Today we'll evaluate Bang & Olufsen a/s (CPH:BO) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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 Bang & Olufsen:

0.044 = ø69m ÷ (ø2.5b - ø886m) (Based on the trailing twelve months to May 2019.)

Therefore, Bang & Olufsen has an ROCE of 4.4%.

View our latest analysis for Bang & Olufsen

Is Bang & Olufsen's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Bang & Olufsen's ROCE appears to be significantly below the 13% average in the Consumer Durables industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, Bang & Olufsen's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

Bang & Olufsen reported an ROCE of 4.4% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. You can see in the image below how Bang & Olufsen's ROCE compares to its industry. Click to see more on past growth.

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. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Bang & Olufsen.

How Bang & Olufsen'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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Bang & Olufsen has total assets of ø2.5b and current liabilities of ø886m. Therefore its current liabilities are equivalent to approximately 36% of its total assets. Bang & Olufsen's middling level of current liabilities have the effect of boosting its ROCE a bit.

What We Can Learn From Bang & Olufsen's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. You might be able to find a better investment than Bang & Olufsen. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.

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. Thank you for reading.