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Today we are going to look at Humana Inc. ( NYSE:HUM ) 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.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. 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.'
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 Humana:
0.19 = US$3.2b ÷ (US$28b - US$12b) (Based on the trailing twelve months to March 2019.)
So, Humana has an ROCE of 19%.
Does Humana Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Humana's ROCE appears to be substantially greater than the 12% average in the Healthcare industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Humana compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, Humana's ROCE appears to be 19%, compared to 3 years ago, when its ROCE was 13%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Humana's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company .
What Are Current Liabilities, And How Do They Affect Humana's 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Humana has total liabilities of US$12b and total assets of US$28b. Therefore its current liabilities are equivalent to approximately 42% of its total assets. Humana has a medium level of current liabilities, which would boost the ROCE.
Our Take On Humana's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. Humana looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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. Thank you for reading.