This analysis is intended to introduce important early concepts to people who are starting to invest and looking to gauge the potential return on investment in ARC Document Solutions Inc (NYSE:ARC).
Purchasing ARC Document Solutions gives you an ownership stake in 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. Therefore, looking at how efficiently ARC Document Solutions 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.
Calculating Return On Capital Employed for ARC
Choosing to invest in ARC Document Solutions comes at the cost of investing in another potentially favourable company. 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. We’ll look at ARC Document Solutions’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. ARC’s ROCE is calculated below:
ROCE Calculation for ARC
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$9.23m ÷ (US$325.80m – US$65.51m) = 3.55%
The calculation above shows that ARC’s earnings were 3.55% of capital employed. A good ROCE hurdle you should aim for in your investments is 15%, which ARC has missed by a wide margin, meaning the company creates a poor amount of earnings from capital employed.
Then why have investors invested?
The underperforming ROCE is not ideal for ARC Document Solutions investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, ARC’s ROCE may increase, in which case your portfolio could benefit from holding the company. Because of this, it is important to look beyond the final value of ARC’s ROCE and understand what is happening to the individual components. Looking at the past 3 year period shows us that ARC weakened investor return on capital employed from 6.89%. In this time, earnings have fallen from US$22.36m to US$9.23m and the amount of capital employed also fell but by a proportionally lesser volume, which suggests the smaller ROCE is due to a decline in earnings relative to capital requirements.
ARC Document Solutions’s ROCE has decreased in the recent past and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. However, 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. ARC Document Solutions’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.
- Future Outlook: What are well-informed industry analysts predicting for ARC’s future growth? Take a look at our free research report of analyst consensus for ARC’s outlook.
- Valuation: What is ARC worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether ARC is currently undervalued by the market.
- 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 firstname.lastname@example.org.