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When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. 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. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after we looked into InterDigital (NASDAQ:IDCC), the trends above didn't look too great.
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. Analysts use this formula to calculate it for InterDigital:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.079 = US$99m ÷ (US$1.6b - US$372m) (Based on the trailing twelve months to December 2021).
Thus, InterDigital has an ROCE of 7.9%. In absolute terms, that's a low return but it's around the Software industry average of 9.3%.
View our latest analysis for InterDigital
Above you can see how the current ROCE for InterDigital compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering InterDigital here for free.
What The Trend Of ROCE Can Tell Us
In terms of InterDigital's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 34% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect InterDigital to turn into a multi-bagger.
What We Can Learn From InterDigital's ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 25% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One more thing, we've spotted 1 warning sign facing InterDigital that you might find interesting.