Is discoverIE Group plc’s (LON:DSCV) Capital Allocation Ability Worth Your Time?

Today we’ll evaluate discoverIE Group plc (LON:DSCV) to determine whether it could have potential as an investment idea. 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. Then we’ll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?

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 discoverIE Group:

0.10 = UK£24m ÷ (UK£328m – UK£96m) (Based on the trailing twelve months to March 2019.)

Therefore, discoverIE Group has an ROCE of 10%.

View our latest analysis for discoverIE Group

Does discoverIE Group Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see discoverIE Group’s ROCE is around the 12% average reported by the Electronic industry. Separate from discoverIE Group’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

We can see that, discoverIE Group currently has an ROCE of 10% compared to its ROCE 3 years ago, which was 7.4%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how discoverIE Group’s ROCE compares to its industry.

LSE:DSCV Past Revenue and Net Income, October 31st 2019
LSE:DSCV Past Revenue and Net Income, October 31st 2019

It is important to remember that ROCE shows past performance, and is 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. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for discoverIE Group.

How discoverIE Group’s Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.

discoverIE Group has total liabilities of UK£96m and total assets of UK£328m. Therefore its current liabilities are equivalent to approximately 29% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

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. discoverIE Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.