This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between Medidata Solutions Inc (NASDAQ:MDSO)’s return fundamentals and stock market performance.
Buying Medidata Solutions makes you a partial owner of the company. 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. Your return is tied to MDSO’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. Therefore, looking at how efficiently Medidata 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.
Medidata Solutions’s Return On Capital Employed
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another 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. To determine Medidata Solutions’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). MDSO’s ROCE is calculated below:
ROCE Calculation for MDSO
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$46m ÷ (US$868m – US$162m) = 6.5%
MDSO’s 6.5% ROCE means that for every $100 you invest, the company creates $6.5. This shows Medidata Solutions provides a dull capital return that is below the 15% ROCE that is typically considered to be a strong benchmark. Nevertheless, if MDSO is clever with their reinvestments or dividend payments, investors can still grow their capital but may fall behind other more attractive opportunities in the market.
Then why have investors invested?
The underperforming ROCE is not ideal for Medidata Solutions investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, MDSO’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 MDSO’s ROCE and understand what is happening to the individual components. If you go back three years, you’ll find that MDSO’s ROCE has increased from 2.8%. With this, the current earnings of US$46m improved from US$16m and capital employed improved as well albeit by a relatively smaller amount, signifying ROCE increased as a result of a greater surge in earnings compared to the business’ use of capital.
Despite MDSO’s current ROCE remains at an unattractive level, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation to determine if an opportunity exists that isn’t made apparent by looking at past data. 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.
- Future Outlook: What are well-informed industry analysts predicting for MDSO’s future growth? Take a look at our free research report of analyst consensus for MDSO’s outlook.
- Valuation: What is MDSO 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 MDSO 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.