To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we’ll want to notice a growing trend returns on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continuously reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Software (ETR:SOW) we aren’t jumping out of our chairs at how returns are trending, but let’s have a deeper look.
Understanding Return On Capital Employed (ROCE)
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from the capital employed in its business. To calculate this metric for Software, this is the formula:
Return on Employed Capital = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.039 = €86m ÷ (€2.8b – €531m) (Based on the trailing twelve months to September 2022).
therefore, Software has an ROCE of 3.9%. Ultimately, that’s a low return and it under-performs the Software industry average of 14%.
View our latest analysis for Software
Above you can see how the current ROCE for Software compares to its prior returns on capital, but there’s only so much you can tell from the past. If you’d like, you can check out the forecasts from the analysts covering Software here for free.
What Does the ROCE Trend For Software Tell Us?
Unfortunately, the trend isn’t great with ROCE falling from 16% five years ago, while capital employed has grown 73%. However, some of the increase in capital employed could be attributed to the recent capital raising that was completed prior to their latest reporting period, so keep that in mind when looking at the decrease in ROCE. Software probably hasn’t received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.
On a related note, Software has decreased its current liabilities to 19% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it’s own money, you could argue this has made the business less efficient at generating ROCE.
To conclude, we’ve found that Software is reinvesting in the business, but returns have been falling. Since the stock has declined 41% over the last five years, investors may not be too optimistic on this trend improving either. On the whole, we aren’t too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
If you want to know some of the risks facing Software we’ve found 2 warning signs (1 doesn’t sit too well with us!) that you should be aware of before investing here.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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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