Today we are going to look at Ocean Bio-Chem, Inc. (NASDAQ:OBCI) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?
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 Ocean Bio-Chem:
0.10 = US$3.6m ÷ (US$39m - US$4.2m) (Based on the trailing twelve months to September 2019.)
Therefore, Ocean Bio-Chem has an ROCE of 10%.
Does Ocean Bio-Chem Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Ocean Bio-Chem's ROCE is around the 13% average reported by the Household Products industry. Independently of how Ocean Bio-Chem compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Ocean Bio-Chem's current ROCE of 10% is lower than its ROCE in the past, which was 18%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Ocean Bio-Chem's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. You can check if Ocean Bio-Chem has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Ocean Bio-Chem'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Ocean Bio-Chem has current liabilities of US$4.2m and total assets of US$39m. As a result, its current liabilities are equal to approximately 11% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Ocean Bio-Chem's ROCE
With that in mind, Ocean Bio-Chem's ROCE appears pretty good. Ocean Bio-Chem shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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