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Why We’re Not Keen On NextGen Healthcare, Inc.’s (NASDAQ:NXGN) 5.9% Return On Capital

Simply Wall St

Today we are going to look at NextGen Healthcare, Inc. (NASDAQ:NXGN) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

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 NextGen Healthcare:

0.059 = US$26m ÷ (US$573m - US$132m) (Based on the trailing twelve months to September 2019.)

So, NextGen Healthcare has an ROCE of 5.9%.

Check out our latest analysis for NextGen Healthcare

Is NextGen Healthcare's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, NextGen Healthcare's ROCE appears to be significantly below the 7.9% average in the Healthcare Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, NextGen Healthcare's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

NextGen Healthcare's current ROCE of 5.9% is lower than its ROCE in the past, which was 9.7%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how NextGen Healthcare's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NasdaqGS:NXGN Past Revenue and Net Income, November 13th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 NextGen Healthcare.

Do NextGen Healthcare's Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

NextGen Healthcare has total assets of US$573m and current liabilities of US$132m. Therefore its current liabilities are equivalent to approximately 23% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

What We Can Learn From NextGen Healthcare's ROCE

That said, NextGen Healthcare's ROCE is mediocre, there may be more attractive investments around. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Thank you for reading.