What trends should we look for if we are to identify stocks that can multiply in value over the long term? First, we would like to identify a growth to recover on capital employed (ROCE) and at the same time, a based capital employed. This shows us that it is a composing machine, capable of continually reinvesting its profits in the business and generating higher returns. In light of this, when we looked at Integrated research (ASX: IRI) and its ROCE trend, we weren’t exactly thrilled.
Return on capital employed (ROCE): what is it?
For those who don’t know, ROCE is a measure of a company’s annual pre-tax profit (its return), relative to the capital employed in the company. To calculate this metric for built-in search, here is the formula:
Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.095 = AU $ 9.8million ÷ (AU $ 135million – AU $ 32million) (Based on the last twelve months up to June 2021).
So, Integrated Research has a ROCE of 9.5%. On its own, that’s a low number, but it’s around the 11% average generated by the software industry.
Check out our latest analysis for integrated research
Above you can see how the current ROCE of integrated research compares to its previous returns on capital, but there is not much you can say about the past. If you wish, here you can view analyst forecasts covering the integrated research for free.
How are the returns evolving?
In terms of Integrated Research’s historic ROCE movements, the trend is not great. Over the past five years, return on capital has declined to 9.5%, down from 37% five years ago. Considering that the company is employing more capital while revenues have declined, this is a bit of a concern. This could mean that the company is losing its competitive advantage or market share, because even if more money is invested in companies, it actually produces a lower return – “less bang for the buck” per se.
On a related note, Integrated Research reduced its current liabilities to 23% of total assets. So we could link some of that to the decrease in ROCE. In addition, it can reduce some aspects of the risk to the business, as the company’s suppliers or short-term creditors are now less funding its operations. Since the company essentially finances a larger portion of its operations with its own money, you could argue that this has made the company less efficient at generating ROCE.
The essentials on the ROCE of integrated research
Based on the above analysis, we find it rather worrying that returns on capital and sales from integrated research have declined, despite the company employing more capital than five years ago. So it’s no surprise that the stock has fallen 21% in the past five years, so it looks like investors are recognizing these changes. Unless there is a change to a more positive trajectory in these metrics, we would look elsewhere.
One more thing to note, we have identified 2 warning signs with Integrated Research and understanding them should be part of your investment process.
If you want to look for solid businesses with great income, check out this free list of companies with good balance sheets and impressive returns on equity.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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