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Why We’re Not Keen On Oil-Dri Corporation of America’s (NYSE:ODC) 5.9% Return On Capital

Simply Wall St

Today we'll look at Oil-Dri Corporation of America (NYSE:ODC) 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. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. 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.

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 Oil-Dri Corporation of America:

0.059 = US$10m ÷ (US$205m - US$33m) (Based on the trailing twelve months to July 2019.)

So, Oil-Dri Corporation of America has an ROCE of 5.9%.

View our latest analysis for Oil-Dri Corporation of America

Does Oil-Dri Corporation of America Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, Oil-Dri Corporation of America's ROCE appears to be significantly below the 13% average in the Household Products industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, Oil-Dri Corporation of America's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

Oil-Dri Corporation of America's current ROCE of 5.9% is lower than 3 years ago, when the company reported a 8.9% ROCE. This makes us wonder if the business is facing new challenges. The image below shows how Oil-Dri Corporation of America's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:ODC Past Revenue and Net Income, October 22nd 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Oil-Dri Corporation of America? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How Oil-Dri Corporation of America's Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Oil-Dri Corporation of America has total liabilities of US$33m and total assets of US$205m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On Oil-Dri Corporation of America's ROCE

If Oil-Dri Corporation of America continues to earn an uninspiring ROCE, there may be better places to invest. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

Oil-Dri Corporation of America is not the only stock that insiders are buying. 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.