Today we’ll look at OMNOVA Solutions Inc. (NYSE:OMN) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we’ll look at what ROCE is and how we calculate it. 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 ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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’.
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 OMNOVA Solutions:
0.11 = US$56m ÷ (US$569m – US$122m) (Based on the trailing twelve months to August 2018.)
Therefore, OMNOVA Solutions has an ROCE of 11%.
Is OMNOVA Solutions’s ROCE Good?
One way to assess ROCE is to compare similar companies. We can see OMNOVA Solutions’s ROCE is around the 12% average reported by the Chemicals industry. Independently of how OMNOVA Solutions compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that OMNOVA Solutions currently has an ROCE of 11%, compared to its ROCE of 6.7% 3 years ago. 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 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect OMNOVA Solutions’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. 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.
OMNOVA Solutions has total liabilities of US$122m and total assets of US$569m. Therefore its current liabilities are equivalent to approximately 21% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On OMNOVA Solutions’s ROCE
This is good to see, and with a sound ROCE, OMNOVA Solutions could be worth a closer look. Of course you might be able to find a better stock than OMNOVA Solutions. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.