Today we’ll evaluate Oil-Dri Corporation of America (NYSE:ODC) to determine whether it could have potential as an investment idea. 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, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?
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 Oil-Dri of America:
0.073 = US$15m ÷ (US$197m – US$36m) (Based on the trailing twelve months to October 2018.)
So, Oil-Dri of America has an ROCE of 7.3%.
Does Oil-Dri of America Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Oil-Dri of America’s ROCE appears meaningfully below the 14% average reported by the Household Products industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Oil-Dri of America’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.
Oil-Dri of America’s current ROCE of 7.3% is lower than its ROCE in the past, which was 12%, 3 years ago. So investors might consider if it has had issues recently.
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 only a point-in-time measure. If Oil-Dri of America is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Oil-Dri of America’s Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Oil-Dri of America has total assets of US$197m and current liabilities of US$36m. Therefore its current liabilities are equivalent to approximately 18% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Oil-Dri of America’s ROCE
If Oil-Dri of America continues to earn an uninspiring ROCE, there may be better places to invest. Of course you might be able to find a better stock than Oil-Dri of America. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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.