Today we'll evaluate Ideagen plc (LON:IDEA) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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 'return' (pre-tax profit) a company generates from capital employed in its 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'.
So, How Do We Calculate ROCE?
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 Ideagen:
0.042 = UK£3.4m ÷ (UK£116m - UK£35m) (Based on the trailing twelve months to April 2019.)
Therefore, Ideagen has an ROCE of 4.2%.
View our latest analysis for Ideagen
Is Ideagen's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Ideagen's ROCE is meaningfully below the Software industry average of 9.5%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Ideagen compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.2% available in government bonds. It is likely that there are more attractive prospects out there.
We can see that, Ideagen currently has an ROCE of 4.2% compared to its ROCE 3 years ago, which was 2.6%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Ideagen's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Ideagen.
Ideagen's Current Liabilities And Their Impact On Its 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.