Here’s why Intellect Design Arena Limited’s Returns On Capital Matters So Much

Here’s why Intellect Design Arena Limited’s Returns On Capital Matters So Much

Today we’ll look at Intellect Design Arena Limited (NSE:INTELLECT) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Intellect Design Arena:

0.0024 = ₹26m ÷ (₹17b – ₹6.2b) (Based on the trailing twelve months to September 2019.)

So, Intellect Design Arena has an ROCE of 0.2%.

View our latest analysis for Intellect Design ArenaIs Intellect Design Arena’s ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Intellect Design Arena’s ROCE appears to be significantly below the 12% average in the Software industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Intellect Design Arena stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.

Intellect Design Arena has an ROCE of 0.2%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving. You can see in the image below how Intellect Design Arena’s ROCE compares to its industry. Click to see more on past growth.

NSEI:INTELLECT Past Revenue and Net Income, November 6th 2019More

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Intellect Design Arena.Intellect Design Arena’s Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.

Intellect Design Arena has total liabilities of ₹6.2b and total assets of ₹17b. As a result, its current liabilities are equal to approximately 36% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Intellect Design Arena’s ROCE is concerning.

Story continuesWhat We Can Learn From Intellect Design Arena’s ROCE

So researching other companies may be a better use of your time. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

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