InterDigital (NASDAQ: IDCC) may struggle to allocate capital
What underlying fundamental trends may indicate that a business may be in decline? A potentially declining business often exhibits two trends, one to recover on capital employed (ROCE) down, and a based capital employed which is also declining. Ultimately, this means that the company earns less per dollar invested and on top of that, it reduces its capital employed base. In light of this, a first glance at InterDigital (NASDAQ: IDCC) we’ve spotted signs that it may be in trouble, so let’s investigate.
Return on capital employed (ROCE): what is it?
Just to clarify if you’re not sure, ROCE is a measure of the pre-tax income (as a percentage) that a business earns on the capital invested in its business. Analysts use this formula to calculate it for InterDigital:
Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.054 = $ 69 million ($ 1.7 billion – $ 418 million) (Based on the last twelve months up to September 2021).
So, InterDigital posts a ROCE of 5.4%. Ultimately, that’s a low return and it’s below the software industry’s 11% average.
NasdaqGS: IDCC Return on capital employed on November 21, 2021
In the graph above, we measured InterDigital’s past ROCE against its past performance, but the future is arguably more important. If you like, you can view the analysts’ forecasts covering InterDigital here for free.
What can we say about InterDigital’s ROCE trend?
In terms of InterDigital’s historic ROCE movements, the trend does not inspire confidence. About five years ago, returns on capital were 23%, but they are now significantly lower than what we saw above. And on the capital employed front, the company is using roughly the same amount of capital as it was back in the day. Companies that exhibit these attributes tend not to shrink, but they can be mature and face pressure on their competitive margins. So, because these trends are generally not conducive to building a multi-bagger, we won’t hold our breath on InterDigital becoming one if things continue as they did.
The key to take away
Overall, lower returns for the same amount of capital employed are not exactly the sign of a dialing machine. And long-term shareholders have seen their investments remain stable over the past five years. With underlying trends not being great in these areas, we would consider looking elsewhere.
One last note, you should inquire about the 5 warning signs we spotted with InterDigital (including 1 that should not be ignored).
Although InterDigital does not generate the highest return, check out this free list of companies that generate high returns on equity with strong balance sheets.
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