Today we are going to look at Mesa Laboratories, Inc. (NASDAQ:MLAB) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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'.
How Do You Calculate Return On Capital Employed?
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 Mesa Laboratories:
0.05 = US$19m ÷ (US$392m - US$17m) (Based on the trailing twelve months to September 2019.)
So, Mesa Laboratories has an ROCE of 5.0%.
Is Mesa Laboratories's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Mesa Laboratories's ROCE appears to be significantly below the 9.0% average in 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 Mesa Laboratories stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
We can see that, Mesa Laboratories currently has an ROCE of 5.0%, less than the 11% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Mesa Laboratories's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Mesa Laboratories.
Do Mesa Laboratories's Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Mesa Laboratories has total assets of US$392m and current liabilities of US$17m. Therefore its current liabilities are equivalent to approximately 4.3% of its total assets. Mesa Laboratories has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
What We Can Learn From Mesa Laboratories's ROCE
Based on this information, Mesa Laboratories appears to be a mediocre business. You might be able to find a better investment than Mesa Laboratories. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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