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Today we'll evaluate Insteel Industries, Inc. (NASDAQ:IIIN) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from 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?
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 Insteel Industries:
0.018 = US$4.9m ÷ (US$293m - US$28m) (Based on the trailing twelve months to September 2019.)
Therefore, Insteel Industries has an ROCE of 1.8%.
Does Insteel Industries Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Insteel Industries's ROCE appears to be significantly below the 12% average in the Building industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Insteel Industries's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
We can see that, Insteel Industries currently has an ROCE of 1.8%, less than the 25% it reported 3 years ago. So investors might consider if it has had issues recently. The image below shows how Insteel Industries's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Insteel Industries.
How Insteel Industries'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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Insteel Industries has total assets of US$293m and current liabilities of US$28m. Therefore its current liabilities are equivalent to approximately 9.7% of its total assets. Insteel Industries has a low level of current liabilities, which have a negligible impact on its already low ROCE.
Our Take On Insteel Industries's ROCE
Nonetheless, there may be better places to invest your capital. But note: make sure you look for a great company, not just the first idea you come across. 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 Insteel Industries 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 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. Thank you for reading.