Today we'll evaluate Insulet Corporation (NASDAQ:PODD) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Insulet:
0.053 = US$61m ÷ (US$1.3b - US$113m) (Based on the trailing twelve months to September 2019.)
So, Insulet has an ROCE of 5.3%.
Is Insulet's ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Insulet's ROCE appears meaningfully below the 9.1% average reported by the Medical Equipment industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Insulet stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
Insulet reported an ROCE of 5.3% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. You can see in the image below how Insulet's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Insulet.
How Insulet's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Insulet has total assets of US$1.3b and current liabilities of US$113m. Therefore its current liabilities are equivalent to approximately 8.9% of its total assets. Insulet has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
Our Take On Insulet's ROCE
Insulet looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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