Today we’ll evaluate Ossen Innovation Co., Ltd. (NASDAQ:OSN) to determine whether it could have potential as an investment idea. 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting 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. 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?
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 Ossen Innovation:
0.099 = US$8.1m ÷ (US$167m – US$41m) (Based on the trailing twelve months to June 2018.)
Therefore, Ossen Innovation has an ROCE of 9.9%.
Does Ossen Innovation Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Ossen Innovation’s ROCE is around the 11% average reported by the Metals and Mining industry. Aside from the industry comparison, Ossen Innovation’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Our data shows that Ossen Innovation currently has an ROCE of 9.9%, compared to its ROCE of 5.4% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Given the industry it operates in, Ossen Innovation could be considered cyclical. If Ossen Innovation is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Ossen Innovation’s Current Liabilities Impact 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ossen Innovation has total assets of US$167m and current liabilities of US$41m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Ossen Innovation’s ROCE
With that in mind, we’re not overly impressed with Ossen Innovation’s ROCE, so it may not be the most appealing prospect. But note: Ossen Innovation 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).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 email@example.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. Thank you for reading.