Why You Should Care About InnovaDerma PLC’s (LON:IDP) Low Return On Capital
Today we'll look at InnovaDerma PLC (LON:IDP) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 InnovaDerma:
0.029 = UK£272k ÷ (UK£12m - UK£2.4m) (Based on the trailing twelve months to December 2018.)
So, InnovaDerma has an ROCE of 2.9%.
See our latest analysis for InnovaDerma
Is InnovaDerma's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, InnovaDerma's ROCE appears to be significantly below the 13% average in the Personal Products industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside InnovaDerma's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.
InnovaDerma has an ROCE of 2.9%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how InnovaDerma's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 InnovaDerma.
InnovaDerma'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. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
InnovaDerma has total liabilities of UK£2.4m and total assets of UK£12m. As a result, its current liabilities are equal to approximately 20% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
What We Can Learn From InnovaDerma's ROCE
That's not a bad thing, however InnovaDerma has a weak ROCE and may not be an attractive investment. You might be able to find a better investment than InnovaDerma. 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 InnovaDerma 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 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. Thank you for reading.
