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What Can We Make Of RF Industries, Ltd.’s (NASDAQ:RFIL) High Return On Capital?

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Simply Wall St
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Today we are going to look at RF Industries, Ltd. (NASDAQ:RFIL) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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'.

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 RF Industries:

0.15 = US$4.6m ÷ (US$36m - US$5.4m) (Based on the trailing twelve months to July 2019.)

Therefore, RF Industries has an ROCE of 15%.

See our latest analysis for RF Industries

Is RF Industries's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, we find that RF Industries's ROCE is meaningfully better than the 12% average in the Electronic industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from RF Industries's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

RF Industries delivered an ROCE of 15%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. The image below shows how RF Industries's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NasdaqGM:RFIL Past Revenue and Net Income, October 1st 2019
NasdaqGM:RFIL Past Revenue and Net Income, October 1st 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is RF Industries? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

RF Industries's Current Liabilities And Their Impact On 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

RF Industries has total liabilities of US$5.4m and total assets of US$36m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

Our Take On RF Industries's ROCE

Overall, RF Industries has a decent ROCE and could be worthy of further research. RF Industries looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

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 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.