In This Article:
When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. So after glancing at the trends within Iress (ASX:IRE), we weren't too hopeful.
What Is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Iress, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.098 = AU$53m ÷ (AU$730m - AU$184m) (Based on the trailing twelve months to December 2024).
Therefore, Iress has an ROCE of 9.8%. In absolute terms, that's a low return and it also under-performs the Software industry average of 14%.
Check out our latest analysis for Iress
Above you can see how the current ROCE for Iress compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Iress .
What The Trend Of ROCE Can Tell Us
The trend of returns that Iress is generating are raising some concerns. The company used to generate 13% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 27% less capital within its operations. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 25%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
The Key Takeaway
In summary, it's unfortunate that Iress is shrinking its capital base and also generating lower returns. And long term shareholders have watched their investments stay flat over the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.