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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. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we 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.
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. In brief, it is a useful tool, but it is not without drawbacks. 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?
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:
0.27 = US$7.8m ÷ (US$33m - US$3.8m) (Based on the trailing twelve months to January 2019.)
Therefore, RF Industries has an ROCE of 27%.
Is RF Industries's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, RF Industries's ROCE is meaningfully higher than the 11% average in the Electronic 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, RF Industries's ROCE is currently very good.
RF Industries delivered an ROCE of 27%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is RF Industries? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How RF Industries'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 counter this, investors can check if a company has high current liabilities relative to total assets.
RF Industries has total liabilities of US$3.8m and total assets of US$33m. Therefore its current liabilities are equivalent to approximately 12% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
The Bottom Line On RF Industries's ROCE
Low current liabilities and high ROCE is a good combination, making RF Industries look quite interesting. You might be able to find a better buy than RF Industries. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like RF Industries better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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.