Returns On Capital Are Showing Encouraging Signs At Orbital (ASX:OEC)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Orbital (ASX:OEC) and its trend of ROCE, we really liked what we saw.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Orbital:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.046 = AU$996k ÷ (AU$36m - AU$15m) (Based on the trailing twelve months to December 2020).

Thus, Orbital has an ROCE of 4.6%. Ultimately, that's a low return and it under-performs the Aerospace & Defense industry average of 7.8%.

See our latest analysis for Orbital

In the above chart we have measured Orbital's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Orbital's ROCE Trending?

We're delighted to see that Orbital is reaping rewards from its investments and has now broken into profitability. The company was generating losses five years ago, but now it's turned around, earning 4.6% which is no doubt a relief for some early shareholders. Additionally, the business is utilizing 50% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 41% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

Our Take On Orbital's ROCE

In a nutshell, we're pleased to see that Orbital has been able to generate higher returns from less capital. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 80% return over the last five years. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

One final note, you should learn about the 4 warning signs we've spotted with Orbital (including 1 which is potentially serious) .

While Orbital may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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