Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Integral Diagnostics (ASX:IDX), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Integral Diagnostics, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.076 = AU$39m ÷ (AU$580m - AU$70m) (Based on the trailing twelve months to June 2020).

Thus, Integral Diagnostics has an ROCE of 7.7%. Even though it's in line with the industry average of 7.9%, it's still a low return by itself.

View our latest analysis for Integral Diagnostics

In the above chart we have measured Integral Diagnostics' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Integral Diagnostics.

What Can We Tell From Integral Diagnostics' ROCE Trend?

We weren't thrilled with the trend because Integral Diagnostics' ROCE has reduced by 64% over the last five years, while the business employed 334% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Integral Diagnostics' earnings and if they change as a result from the capital raise. It's also worth noting the company's latest EBIT figure is within 10% of the previous year, so it's fair to assign the ROCE drop largely to the capital raise.

On a side note, Integral Diagnostics has done well to pay down its current liabilities to 12% 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.

What We Can Learn From Integral Diagnostics' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Integral Diagnostics. And the stock has done incredibly well with a 183% return over the last three years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

On a final note, we've found 2 warning signs for Integral Diagnostics that we think you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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