Here’s why RADA Electronic Industries Ltd.’s (NASDAQ:RADA) Returns On Capital Matters So Much

Today we’ll evaluate RADA Electronic Industries Ltd. (NASDAQ:RADA) to determine whether it could have potential as an investment idea. 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 of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its c
urrent liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.

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 RADA Electronic Industries:

0.0087 = US$2.0m ÷ (US$38m – US$7.3m) (Based on the trailing twelve months to September 2018.)

Therefore, RADA Electronic Industries has an ROCE of 0.9%.

See our latest analysis for RADA Electronic Industries

Does RADA Electronic Industries Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see RADA Electronic Industries’s ROCE is meaningfully below the Aerospace & Defense industry average of 11%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how RADA Electronic Industries compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. There are potentially more appealing investments elsewhere.

RADA Electronic Industries has an ROCE of 0.9%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving.