U.S. Markets closed

Why discoverIE Group plc’s (LON:DSCV) Use Of Investor Capital Doesn’t Look Great

Simply Wall St

Want to participate in a research study? Help shape the future of investing tools and earn a $60 gift card!

Today we are going to look at discoverIE Group plc (LON:DSCV) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 discoverIE Group:

0.099 = UK£22m ÷ (UK£308m - UK£89m) (Based on the trailing twelve months to September 2018.)

So, discoverIE Group has an ROCE of 9.9%.

View our latest analysis for discoverIE Group

Does discoverIE Group Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, discoverIE Group's ROCE appears meaningfully below the 14% average reported by the Electronic industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how discoverIE Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

LSE:DSCV Past Revenue and Net Income, April 1st 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 discoverIE Group.

Do discoverIE Group's Current Liabilities Skew 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

discoverIE Group has total liabilities of UK£89m and total assets of UK£308m. As a result, its current liabilities are equal to approximately 29% of its total assets. Low current liabilities are not boosting the ROCE too much.

What We Can Learn From discoverIE Group's ROCE

This is good to see, and with a sound ROCE, discoverIE Group could be worth a closer look. But note: discoverIE Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.