InterDigital's (NASDAQ:IDCC) Returns On Capital Tell Us There Is Reason To Feel Uneasy

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into InterDigital (NASDAQ:IDCC), we weren't too upbeat about how things were going.

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. The formula for this calculation on InterDigital is:

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

0.094 = US$154m ÷ (US$1.9b - US$271m) (Based on the trailing twelve months to December 2022).

Thus, InterDigital has an ROCE of 9.4%. In absolute terms, that's a low return but it's around the Software industry average of 9.5%.

See our latest analysis for InterDigital

In the above chart we have measured InterDigital's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for InterDigital.

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at InterDigital. About five years ago, returns on capital were 20%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect InterDigital to turn into a multi-bagger.

What We Can Learn From InterDigital's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Investors must expect better things on the horizon though because the stock has risen 6.6% in the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

One more thing to note, we've identified 1 warning sign with InterDigital and understanding it should be part of your investment process.

While InterDigital 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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