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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, while the ROCE is currently high for IDP Education (ASX:IEL), we aren't jumping out of our chairs because returns are decreasing.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for IDP Education, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = AU$221m ÷ (AU$1.2b - AU$351m) (Based on the trailing twelve months to June 2023).
Therefore, IDP Education has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Consumer Services industry average of 7.2%.
See our latest analysis for IDP Education
In the above chart we have measured IDP Education's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering IDP Education here for free.
What Does the ROCE Trend For IDP Education Tell Us?
On the surface, the trend of ROCE at IDP Education doesn't inspire confidence. Historically returns on capital were even higher at 44%, but they have dropped over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
On a related note, IDP Education has decreased its current liabilities to 28% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
In Conclusion...
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for IDP Education. And the stock has followed suit returning a meaningful 94% to shareholders over the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.