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Here’s why Opera Limited’s (NASDAQ:OPRA) Returns On Capital Matters So Much

Simply Wall St

Today we are going to look at Opera Limited (NASDAQ:OPRA) 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. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

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'.

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 Opera:

0.023 = US$21m ÷ (US$984m - US$82m) (Based on the trailing twelve months to September 2019.)

So, Opera has an ROCE of 2.3%.

See our latest analysis for Opera

Is Opera's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Opera's ROCE appears meaningfully below the 9.8% average reported by the Software industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Opera stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.

The image below shows how Opera's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NasdaqGS:OPRA Past Revenue and Net Income, December 24th 2019

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Opera.

What Are Current Liabilities, And How Do They Affect Opera's 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Opera has total assets of US$984m and current liabilities of US$82m. Therefore its current liabilities are equivalent to approximately 8.4% of its total assets. Opera has a low level of current liabilities, which have a negligible impact on its already low ROCE.

What We Can Learn From Opera's ROCE

Still, investors could probably find more attractive prospects with better performance out there. 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).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.

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. Thank you for reading.