Why Ideagen plc’s (LON:IDEA) Use Of Investor Capital Doesn’t Look Great

Today we’ll look at Ideagen plc (LON:IDEA) 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.

First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?

The formula for calculating the return on capital employed is:

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

Or for Ideagen:

0.022 = UK£1.8m ÷ (UK£114m – UK£33m) (Based on the trailing twelve months to October 2018.)

So, Ideagen has an ROCE of 2.2%.

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Is Ideagen’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Ideagen’s ROCE appears meaningfully below the 10% average reported by the Software industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Ideagen stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.

In our analysis, Ideagen’s ROCE appears to be 2.2%, compared to 3 years ago, when its ROCE was 1.6%. This makes us think the business might be improving.

AIM:IDEA Past Revenue and Net Income, May 24th 2019
AIM:IDEA Past Revenue and Net Income, May 24th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Ideagen’s Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.

Ideagen has total liabilities of UK£33m and total assets of UK£114m. As a result, its current liabilities are equal to approximately 29% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

The Bottom Line On Ideagen’s ROCE

Ideagen has a poor ROCE, and there may be better investment prospects out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like Ideagen better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.