Returns On Capital At Integral Diagnostics (ASX:IDX) Paint An Interesting Picture

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Integral Diagnostics (ASX:IDX) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Integral Diagnostics is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.076 = AU$39m ÷ (AU$580m - AU$70m) (Based on the trailing twelve months to June 2020).

So, Integral Diagnostics has an ROCE of 7.7%. Even though it's in line with the industry average of 7.8%, it's still a low return by itself.

See our latest analysis for Integral Diagnostics

Above you can see how the current ROCE for Integral Diagnostics compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Integral Diagnostics Tell Us?

Unfortunately, the trend isn't great with ROCE falling from 21% five years ago, while capital employed has grown 334%. Usually this isn't ideal, but given Integral Diagnostics conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Integral Diagnostics' earnings and if they change as a result from the capital raise. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.

On a related note, Integral Diagnostics has decreased its current liabilities to 12% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Integral Diagnostics' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Integral Diagnostics. And long term investors must be optimistic going forward because the stock has returned a huge 180% to shareholders in the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

If you'd like to know about the risks facing Integral Diagnostics, we've discovered 4 warning signs that you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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