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Today we are going to look at Azure Healthcare Limited (ASX:AZV) to see whether it might be an attractive investment prospect. 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 of all, we’ll work out how to 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Azure Healthcare:

0.14 = AU$1.3m ÷ (AU$17m – AU$7.2m) (Based on the trailing twelve months to June 2018.)

So, Azure Healthcare has an ROCE of 14%.

View our latest analysis for Azure Healthcare

Does Azure Healthcare Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, Azure Healthcare’s ROCE appears to be around the 13% 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 has an ROCE of 14%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. If Azure Healthcare is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Azure 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Azure Healthcare has total liabilities of AU$7.2m and total assets of AU$17m. As a result, its current liabilities are equal to approximately 43% of its total assets. Azure Healthcare has a medium level of current liabilities, which would boost the ROCE.

What We Can Learn From Azure Healthcare’s ROCE

While its ROCE looks good, it’s worth remembering that the current liabilities are making the business 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).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.