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Why You Should Care About Danaher Corporation’s (NYSE:DHR) Low Return On Capital

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Today we are going to look at Danaher Corporation (NYSE:DHR) 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 up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.

What is 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. Generally speaking a higher ROCE is better. 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?

The formula for calculating the return on capital employed is:

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

Or for Danaher:

0.079 = US$3.4b ÷ (US$48b – US$4.8b) (Based on the trailing twelve months to December 2018.)

So, Danaher has an ROCE of 7.9%.

See our latest analysis for Danaher

Does Danaher Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, Danaher’s ROCE appears to be significantly below the 11% average in the Medical Equipment industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Danaher 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.

As we can see, Danaher currently has an ROCE of 7.9% compared to its ROCE 3 years ago, which was 5.5%. This makes us think the business might be improving.

NYSE:DHR Last Perf February 18th 19
NYSE:DHR Last Perf February 18th 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Danaher.

Danaher’s Current Liabilities And Their Impact On Its 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Danaher has total liabilities of US$4.8b and total assets of US$48b. Therefore its current liabilities are equivalent to approximately 10% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On Danaher’s ROCE

With that in mind, we’re not overly impressed with Danaher’s ROCE, so it may not be the most appealing prospect. But note: Danaher 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).

I will like Danaher better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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 editorial-team@simplywallst.com. 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.