Why We’re Not Keen On Oil-Dri Corporation of America’s (NYSE:ODC) 9.2% Return On Capital

Today we are going to look at Oil-Dri Corporation of America (NYSE:ODC) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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?

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 Oil-Dri Corporation of America:

0.092 = US$16m ÷ (US$209m - US$34m) (Based on the trailing twelve months to January 2020.)

So, Oil-Dri Corporation of America has an ROCE of 9.2%.

See our latest analysis for Oil-Dri Corporation of America

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

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Oil-Dri Corporation of America's ROCE appears meaningfully below the 14% average reported by the Household Products industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, 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. Investors may wish to consider higher-performing investments.

We can see that, Oil-Dri Corporation of America currently has an ROCE of 9.2% compared to its ROCE 3 years ago, which was 6.1%. This makes us think about whether the company has been reinvesting shrewdly. 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.

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. You can check if Oil-Dri Corporation of America has cyclical profits 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Oil-Dri Corporation of America has current liabilities of US$34m and total assets of US$209m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

Our Take On Oil-Dri Corporation of America's ROCE

With that in mind, we're not overly impressed with Oil-Dri Corporation of America's ROCE, so it may not be the most appealing prospect. 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).

I will like Oil-Dri Corporation of America better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.