Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in IDE Group Holdings' (LON:IDE) returns on capital, so let's have a look.
What Is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for IDE Group Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.079 = UK£860k ÷ (UK£16m - UK£4.6m) (Based on the trailing twelve months to June 2022).
So, IDE Group Holdings has an ROCE of 7.9%. Ultimately, that's a low return and it under-performs the IT industry average of 9.9%.
In the above chart we have measured IDE Group Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering IDE Group Holdings here for free.
What The Trend Of ROCE Can Tell Us
IDE Group Holdings has not disappointed in regards to ROCE growth. The figures show that over the last five years, returns on capital have grown by 491%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Speaking of capital employed, the company is actually utilizing 84% less than it was five years ago, which can be indicative of a business that's improving its efficiency. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.
The Bottom Line On IDE Group Holdings' ROCE
In a nutshell, we're pleased to see that IDE Group Holdings has been able to generate higher returns from less capital. And since the stock has dived 97% over the last five years, there may be other factors affecting the company's prospects. Regardless, we think the underlying fundamentals warrant this stock for further investigation.
If you'd like to know more about IDE Group Holdings, we've spotted 4 warning signs, and 3 of them are a bit unpleasant.
While IDE Group Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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