Today we’ll look at Immunodiagnostic Systems Holdings PLC (LON:IDH) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.
So, How Do We Calculate ROCE?
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 Immunodiagnostic Systems Holdings:
0.02 = UK£1.2m ÷ (UK£68m – UK£7.1m) (Based on the trailing twelve months to September 2019.)
Therefore, Immunodiagnostic Systems Holdings has an ROCE of 2.0%.
Is Immunodiagnostic Systems Holdings’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Immunodiagnostic Systems Holdings’s ROCE appears to be significantly below the 11% average in the Medical Equipment industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Immunodiagnostic Systems Holdings’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
We can see that, Immunodiagnostic Systems Holdings currently has an ROCE of 2.0%, less than the 3.0% it reported 3 years ago. This makes us wonder if the business is facing new challenges. Take a look at the image below to see how Immunodiagnostic Systems Holdings’s past growth compares to the average in its industry.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Immunodiagnostic Systems Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Immunodiagnostic Systems Holdings’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 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.
Immunodiagnostic Systems Holdings has total assets of UK£68m and current liabilities of UK£7.1m. Therefore its current liabilities are equivalent to approximately 10% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On Immunodiagnostic Systems Holdings’s ROCE
Immunodiagnostic Systems Holdings has a poor ROCE, and there may be better investment prospects out there. You might be able to find a better investment than Immunodiagnostic Systems Holdings. 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).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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