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Why We’re Not Keen On Hill-Rom Holdings, Inc.’s (NYSE:HRC) 10% Return On Capital

Gerald Huddleston

Today we’ll look at Hill-Rom Holdings, Inc. ( NYSE:HRC ) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the 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.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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’.

So, How Do We Calculate ROCE?

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 Hill-Rom Holdings:

0.10 = US$384m ÷ (US$4.4b – US$662m) (Based on the trailing twelve months to September 2018.)

Therefore, Hill-Rom Holdings has an ROCE of 10%.

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Does Hill-Rom Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. It appears that Hill-Rom Holdings’s ROCE is fairly close to the Medical Equipment industry average of 11%. Setting aside the industry comparison for now, Hill-Rom Holdings’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.

As we can see, Hill-Rom Holdings currently has an ROCE of 10% compared to its ROCE 3 years ago, which was 4.8%. This makes us think about whether the company has been reinvesting shrewdly.

NYSE:HRC Last Perf January 23rd 19

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company .

How Hill-Rom Holdings’s Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Hill-Rom Holdings has total liabilities of US$662m and total assets of US$4.4b. As a result, its current liabilities are equal to approximately 15% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

The Bottom Line On Hill-Rom Holdings’s ROCE

If Hill-Rom Holdings continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better buy than Hill-Rom Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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 .