Today we'll evaluate Hanza Holding AB (publ) (STO:HANZA) 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. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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'.

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 Hanza Holding:

0.084 = kr64m ÷ (kr1.3b - kr520m) (Based on the trailing twelve months to March 2019.)

Therefore, Hanza Holding has an ROCE of 8.4%.

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Does Hanza Holding Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, Hanza Holding's ROCE appears to be significantly below the 13% average in the Electronic industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Hanza Holding stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

Our data shows that Hanza Holding currently has an ROCE of 8.4%, compared to its ROCE of 3.1% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.

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 Hanza Holding.

What Are Current Liabilities, And How Do They Affect Hanza Holding's ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Hanza Holding has total assets of kr1.3b and current liabilities of kr520m. Therefore its current liabilities are equivalent to approximately 41% of its total assets. Hanza Holding's middling level of current liabilities have the effect of boosting its ROCE a bit.

What We Can Learn From Hanza Holding's ROCE

Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.