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Today we’ll look at Azure Healthcare Limited (ASX:AZV) and reflect on its potential as an investment.
Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we’ll look at what ROCE is and how we calculate it.
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 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.
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’.
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 Azure Healthcare:
0.14 = AU$1.3m ÷ (AU$17m – AU$7.2m) (Based on the trailing twelve months to June 2018.)
Therefore, Azure Healthcare has an ROCE of 14%.
Is Azure Healthcare’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses.
Using our data, Azure Healthcare’s ROCE appears to be around the 14% average of the Medical Equipment industry.
Independently of how Azure Healthcare compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Azure Healthcare delivered an ROCE of 14%, which is better than 3 years ago, as was making losses back then.
That implies the business has been improving.
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.
This is because ROCE only looks at one year, instead of considering returns across a whole cycle.
How cyclical is Azure Healthcare? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Azure Healthcare’s Current Liabilities And Their Impact On 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.
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.
Azure Healthcare has total assets of AU$17m and current liabilities of AU$7.2m.
As a result, its current liabilities are equal to approximately 43% of its total assets.
With this level of current liabilities, Azure Healthcare’s ROCE is boosted somewhat.
What We Can Learn From Azure Healthcare’s ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better.
But note: Azure Healthcare may not be the best stock to buy. 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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. On rare occasion, data errors may occur. Thank you for reading.
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