I am writing today to help inform people who are new to the stock market and want to begin learning the link between Universal Biosensors Inc (ASX:UBI)’s return fundamentals and stock market performance.
Buying Universal Biosensors makes you a partial owner of the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. To understand Universal Biosensors’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
ROCE: Explanation and Calculation
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Universal Biosensors is good at growing investor capital. UBI’s ROCE is calculated below:
ROCE Calculation for UBI
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = AU$39m ÷ (AU$90m – AU$29m) = 68%
As you can see, UBI earned A$68.2 from every A$100 you invested over the previous twelve months. This shows Universal Biosensors provides a great return on capital employed that is well above the 15% ROCE that is typically considered to be a strong benchmark. As a result, if UBI is clever with their reinvestments or dividend payments, investors can grow their capital at an enviable rate over time.
Can any of this change?
Universal Biosensors’s relatively strong ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Universal Biosensors is in a favourable position, but this can change if these factors underperform. Because of this, it is important to look beyond the final value of UBI’s ROCE and understand what is happening to the individual components. If you go back three years, you’ll find that UBI’s ROCE has increased from -22%. We can see that earnings have increased from -AU$4.8m to AU$39m whilst capital employed also increased but to a smaller extent, which means the company has been able to improve ROCE by driving up earnings relative to the capital invested in the business.
Universal Biosensors’s ROCE has increased in the recent past and is above a benchmark that makes the company a potentially attractive stock that can achieve a solid return on investment. As an investor this is the type of situation you look for, but return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like the management team. It’s important to account for factors like this because you cannot be sure if this trend will continue or reverse due to reasons that cannot be seen by looking in the past. Universal Biosensors’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for Universal Biosensors’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.