Today we'll look at Intercede Group plc (LON:IGP) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
How Do You Calculate Return On Capital Employed?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Intercede Group:
0.15 = UK£625k ÷ (UK£9.5m - UK£5.4m) (Based on the trailing twelve months to September 2019.)
So, Intercede Group has an ROCE of 15%.
Is Intercede Group's ROCE Good?
One way to assess ROCE is to compare similar companies. Intercede Group's ROCE appears to be substantially greater than the 10% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Intercede Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Intercede Group reported an ROCE of 15% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. The image below shows how Intercede Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. How cyclical is Intercede Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Intercede Group's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Intercede Group has current liabilities of UK£5.4m and total assets of UK£9.5m. Therefore its current liabilities are equivalent to approximately 57% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
What We Can Learn From Intercede Group's ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. There might be better investments than Intercede Group out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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