Today we'll look at Ovostar Union N.V. (WSE:OVO) and reflect on its potential as an investment. 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. 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 measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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?

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 Ovostar Union:

0.17 = US$23m ÷ (US$146m - US$13m) (Based on the trailing twelve months to December 2018.)

Therefore, Ovostar Union has an ROCE of 17%.

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Does Ovostar Union Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Ovostar Union's ROCE appears to be substantially greater than the 13% average in the Food industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Ovostar Union sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Ovostar Union's current ROCE of 17% is lower than 3 years ago, when the company reported a 32% ROCE. So investors might consider if it has had issues recently.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Ovostar Union.

What Are Current Liabilities, And How Do They Affect Ovostar Union's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Ovostar Union has total liabilities of US$13m and total assets of US$146m. Therefore its current liabilities are equivalent to approximately 8.9% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Ovostar Union earns a sound return on capital employed.

The Bottom Line On Ovostar Union's ROCE

If Ovostar Union can continue reinvesting in its business, it could be an attractive prospect. There might be better investments than Ovostar Union 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.

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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.