Today we are going to look at Ossen Innovation Co., Ltd. (NASDAQ:OSN) 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. Second, we'll look at its ROCE compared 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Ossen Innovation:
0.12 = US$15m ÷ (US$162m - US$42m) (Based on the trailing twelve months to December 2018.)
So, Ossen Innovation has an ROCE of 12%.
Does Ossen Innovation Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Ossen Innovation's ROCE appears to be substantially greater than the 8.6% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Ossen Innovation's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that , Ossen Innovation currently has an ROCE of 12% compared to its ROCE 3 years ago, which was 9.8%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Ossen Innovation's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Given the industry it operates in, Ossen Innovation could be considered cyclical. How cyclical is Ossen Innovation? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Ossen Innovation's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Ossen Innovation has total assets of US$162m and current liabilities of US$42m. As a result, its current liabilities are equal to approximately 26% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Ossen Innovation's ROCE
With that in mind, Ossen Innovation's ROCE appears pretty good. Ossen Innovation 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.
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 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.