Today we are going to look at Orion Energy Systems, Inc. (NASDAQ:OESX) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we’ll look at what ROCE is and how we calculate it. 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.
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. Generally speaking a higher ROCE is better. 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.
How Do You Calculate Return On Capital Employed?
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 Orion Energy Systems:
0.38 = US$13m ÷ (US$57m – US$23m) (Based on the trailing twelve months to December 2019.)
Therefore, Orion Energy Systems has an ROCE of 38%.
Does Orion Energy Systems Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Orion Energy Systems’s ROCE appears to be substantially greater than the 9.9% average in the Electrical 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. Putting aside its position relative to its industry for now, in absolute terms, Orion Energy Systems’s ROCE is currently very good.
Orion Energy Systems has an ROCE of 38%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Orion Energy Systems’s past growth compares to other companies.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Orion Energy Systems.
Do Orion Energy Systems’s Current Liabilities Skew Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Orion Energy Systems has total assets of US$57m and current liabilities of US$23m. As a result, its current liabilities are equal to approximately 41% of its total assets. Orion Energy Systems has a medium level of current liabilities, boosting its ROCE somewhat.
What We Can Learn From Orion Energy Systems’s ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. There might be better investments than Orion Energy Systems out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like Orion Energy Systems better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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