What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in Bang & Olufsen's (CPH:BO) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
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. The formula for this calculation on Bang & Olufsen is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.041 = kr.54m ÷ (kr.2.5b - kr.1.2b) (Based on the trailing twelve months to May 2022).
Thus, Bang & Olufsen has an ROCE of 4.1%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 12%.
Above you can see how the current ROCE for Bang & Olufsen compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Bang & Olufsen here for free.
The Trend Of ROCE
We're delighted to see that Bang & Olufsen is reaping rewards from its investments and has now broken into profitability. Historically the company was generating losses but as we can see from the latest figures referenced above, they're now earning 4.1% on their capital employed. In regards to capital employed, Bang & Olufsen is using 31% less capital than it was five years ago, which on the surface, can indicate that the business has become more efficient at generating these returns. This could potentially mean that the company is selling some of its assets.
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. The current liabilities has increased to 47% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. And with current liabilities at those levels, that's pretty high.
The Key Takeaway
From what we've seen above, Bang & Olufsen has managed to increase it's returns on capital all the while reducing it's capital base. Given the stock has declined 69% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.
On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.