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Are Integral Diagnostics Limited’s (ASX:IDX) High Returns Really That Great?

Simply Wall St

Today we are going to look at Integral Diagnostics Limited (ASX:IDX) to see whether it might be an attractive investment prospect. 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. Second, we'll look at its ROCE compared to similar companies. 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'.

How Do You Calculate Return On Capital Employed?

Analysts use this formula to calculate return on capital employed:

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

Or for Integral Diagnostics:

0.14 = AU$38m ÷ (AU$315m - AU$39m) (Based on the trailing twelve months to June 2019.)

So, Integral Diagnostics has an ROCE of 14%.

Check out our latest analysis for Integral Diagnostics

Does Integral Diagnostics Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Integral Diagnostics's ROCE appears to be substantially greater than the 10.0% average in the Healthcare industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Integral Diagnostics sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

You can click on the image below to see (in greater detail) how Integral Diagnostics's past growth compares to other companies.

ASX:IDX Past Revenue and Net Income, November 29th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Integral Diagnostics.

Integral Diagnostics's Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.

Integral Diagnostics has total liabilities of AU$39m and total assets of AU$315m. As a result, its current liabilities are equal to approximately 12% of its total assets. Low current liabilities are not boosting the ROCE too much.

The Bottom Line On Integral Diagnostics's ROCE

With that in mind, Integral Diagnostics's ROCE appears pretty good. There might be better investments than Integral Diagnostics out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

Integral Diagnostics is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.

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. Thank you for reading.