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Today we'll look at Ocean Grown Abalone Limited (ASX:OGA) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE 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 '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 Ocean Grown Abalone:
0.12 = AU$2.4m ÷ (AU$20m - AU$955k) (Based on the trailing twelve months to June 2019.)
Therefore, Ocean Grown Abalone has an ROCE of 12%.
Is Ocean Grown Abalone's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Ocean Grown Abalone's ROCE is meaningfully better than the 9.7% average in the Food industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Ocean Grown Abalone sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
The image below shows how Ocean Grown Abalone'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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. You can check if Ocean Grown Abalone has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Ocean Grown Abalone'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Ocean Grown Abalone has total liabilities of AU$955k and total assets of AU$20m. As a result, its current liabilities are equal to approximately 4.8% of its total assets. Low current liabilities have only a minimal impact on Ocean Grown Abalone's ROCE, making its decent returns more credible.
The Bottom Line On Ocean Grown Abalone's ROCE
This is good to see, and while better prospects may exist, Ocean Grown Abalone seems worth researching further. There might be better investments than Ocean Grown Abalone 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.
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 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.