Today we'll look at Omega Flex, Inc. (NASDAQ:OFLX) and reflect on its potential as an investment. 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. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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'.
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 Omega Flex:
0.35 = US$25m ÷ (US$88m - US$16m) (Based on the trailing twelve months to June 2019.)
So, Omega Flex has an ROCE of 35%.
Does Omega Flex Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Omega Flex's ROCE appears to be substantially greater than the 12% average in the Machinery industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Omega Flex's ROCE currently appears to be excellent.
Omega Flex's current ROCE of 35% is lower than 3 years ago, when the company reported a 48% ROCE. So investors might consider if it has had issues recently. You can see in the image below how Omega Flex's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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, after all, simply a snap shot of a single year. How cyclical is Omega Flex? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Omega Flex's Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Omega Flex has total assets of US$88m and current liabilities of US$16m. As a result, its current liabilities are equal to approximately 18% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Omega Flex's ROCE
Low current liabilities and high ROCE is a good combination, making Omega Flex look quite interesting. There might be better investments than Omega Flex out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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