Today we'll look at Ocean Bio-Chem, Inc. (NASDAQ:OBCI) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Ocean Bio-Chem:

0.12 = US$4.0m ÷ (US$37m - US$3.9m) (Based on the trailing twelve months to March 2019.)

So, Ocean Bio-Chem has an ROCE of 12%.

View our latest analysis for Ocean Bio-Chem

Is Ocean Bio-Chem's ROCE Good?

One way to assess ROCE is to compare similar companies. It appears that Ocean Bio-Chem's ROCE is fairly close to the Household Products industry average of 14%. Regardless of where Ocean Bio-Chem sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

You can see in the image below how Ocean Bio-Chem's ROCE compares to its industry. Click to see more on past growth.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Ocean Bio-Chem is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Ocean Bio-Chem'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.