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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. 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.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. Overall, it is a valuable metric that has its flaws. 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?
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:
0.14 = US$4.6m ÷ (US$38m - US$6.1m) (Based on the trailing twelve months to October 2019.)
Therefore, RF Industries has an ROCE of 14%.
Is RF Industries's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that RF Industries's ROCE is meaningfully better than the 11% average in the Electronic industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from RF Industries's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
RF Industries reported an ROCE of 14% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. You can see in the image below how RF Industries's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. 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 RF Industries.
What Are Current Liabilities, And How Do They Affect RF Industries'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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
RF Industries has current liabilities of US$6.1m and total assets of US$38m. As a result, its current liabilities are equal to approximately 16% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On RF Industries's ROCE
With that in mind, RF Industries's ROCE appears pretty good. RF Industries 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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