Today we'll evaluate Galenica AG (VTX:GALE) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE 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 'return' (pre-tax profit) a company generates from 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. 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?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Galenica:

0.073 = CHF117m ÷ (CHF2.2b - CHF614m) (Based on the trailing twelve months to June 2019.)

Therefore, Galenica has an ROCE of 7.3%.

View our latest analysis for Galenica

Is Galenica's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. It appears that Galenica's ROCE is fairly close to the Healthcare industry average of 8.0%. Separate from how Galenica 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.

Galenica's current ROCE of 7.3% is lower than its ROCE in the past, which was 9.9%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Galenica'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 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Galenica.

What Are Current Liabilities, And How Do They Affect Galenica's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.