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%.
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.
Ideagen has total liabilities of UK£35m and total assets of UK£116m. Therefore its current liabilities are equivalent to approximately 30% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On Ideagen's ROCE
That's not a bad thing, however Ideagen has a weak ROCE and may not be an attractive investment. You might be able to find a better investment than Ideagen. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like Ideagen better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.