What Do You Get For Owning IDP Education Limited (ASX:IEL)?

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and looking to gauge the potential return on investment in IDP Education Limited (ASX:IEL).

If you purchase a IEL share you are effectively becoming a partner with many other shareholders. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Therefore, looking at how efficiently IDP Education is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.

Check out our latest analysis for IDP Education

IDP Education's Return On Capital Employed

You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. The cost of missing out on another opportunity comes in the form of the potential long term gain you could've received, which is dependent on the gap between the return on capital you could've achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. We'll look at IDP Education’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. I have calculated IDP Education’s ROCE for you below:

The calculation above shows that IEL’s earnings were 43.15% of capital employed. A good ROCE hurdle you should aim for in your investments is 15%, which is exceeded by IEL and means the company creates an excellent amount of earnings on capital employed. If this can be sustained with good reinvestment opportunities or dividend distributions your capital has the potential to compound extremely well over time.

Not so fast

Although IDP Education is in a favourable position, you should know that this could change if the company is unable to maintain a strong ROCE above the benchmark, which will depend on the behaviour of the underlying variables (EBT and capital employed). Because of this, it is important to look beyond the final value of IEL’s ROCE and understand what is happening to the individual components. Looking three years in the past, it is evident that IEL's ROCE has deteriorated from 43.68%, indicating the company's capital returns have declined. Over the same period, EBT went from AU$45.85m to AU$70.47m but capital employed has grown by a relatively larger volume as a result of an increase in total assets , which suggests investor's ROCE has fallen because the company requires more capital to create earnings despite the previous growth in EBT.

Next Steps

Although IDP Education’s ROCE has decreased over the past few years, the company still remains an attractive candidate that is capable of producing solid capital returns and a potentially strong return on investment. It is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as future prospects and valuation. Without considering these fundamentals, you cannot be sure if the downward path is a signal to run, or just a blip in an otherwise solid return profile. If you're interested in diving deeper, take a look at what I've linked below for further information on these fundamentals and other potential investment opportunities.

1. Future Outlook: What are well-informed industry analysts predicting for IEL’s future growth? Take a look at our free research report of analyst consensus for IEL’s outlook.
2. Valuation: What is IEL worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether IEL is currently mispriced by the market.
3. 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 pass 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 editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.