Today we'll evaluate Koss Corporation (NASDAQ:KOSS) 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Koss:
0.031 = US$623k ÷ (US$23m - US$2.8m) (Based on the trailing twelve months to March 2019.)
Therefore, Koss has an ROCE of 3.1%.
Is Koss's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Koss's ROCE appears meaningfully below the 11% average reported by the Consumer Durables industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Koss compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. There are potentially more appealing investments elsewhere.
The image below shows how Koss'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 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. How cyclical is Koss? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Koss's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Koss has total assets of US$23m and current liabilities of US$2.8m. As a result, its current liabilities are equal to approximately 12% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On Koss's ROCE
That's not a bad thing, however Koss has a weak ROCE and may not be an attractive investment. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.