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What Can We Make Of Omega Flex, Inc.’s (NASDAQ:OFLX) High Return On Capital?

Simply Wall St

Today we are going to look at Omega Flex, Inc. (NASDAQ:OFLX) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Omega Flex:

0.41 = US$27m ÷ (US$81m – US$17m) (Based on the trailing twelve months to December 2018.)

Therefore, Omega Flex has an ROCE of 41%.

See our latest analysis for Omega Flex

Does Omega Flex Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Omega Flex’s ROCE is meaningfully higher than the 12% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Omega Flex’s ROCE is currently very good.

NasdaqGM:OFLX Past Revenue and Net Income, March 7th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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.

What Are Current Liabilities, And How Do They Affect Omega Flex’s ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Omega Flex has total assets of US$81m and current liabilities of US$17m. As a result, its current liabilities are equal to approximately 20% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

What We Can Learn From Omega Flex’s ROCE

This is good to see, and with such a high ROCE, Omega Flex may be worth a closer look. Of course you might be able to find a better stock than Omega Flex. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 editorial-team@simplywallst.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.