Today we'll evaluate Best Buy Co., Inc. (NYSE:BBY) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
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. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding 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. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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'.
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 Best Buy:
0.27 = US$2.0b ÷ (US$15b - US$7.2b) (Based on the trailing twelve months to May 2019.)
So, Best Buy has an ROCE of 27%.
Is Best Buy's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Best Buy's ROCE is meaningfully better than the 10% average in the Specialty Retail 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. Setting aside the comparison to its industry for a moment, Best Buy's ROCE in absolute terms currently looks quite high.
You can see in the image below how Best Buy's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Best Buy.
Best Buy's Current Liabilities And Their Impact On 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 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.
Best Buy has total assets of US$15b and current liabilities of US$7.2b. As a result, its current liabilities are equal to approximately 49% of its total assets. A medium level of current liabilities boosts Best Buy's ROCE somewhat.
Our Take On Best Buy's ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. There might be better investments than Best Buy 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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If you spot an error that warrants correction, please contact the editor at email@example.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.