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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. And in light of that, the trends we're seeing at Altium's (ASX:ALU) look very promising so lets take a look.
What is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Altium is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.29 = US$63m ÷ (US$296m - US$82m) (Based on the trailing twelve months to June 2020).
Therefore, Altium has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Software industry average of 13%.
Above you can see how the current ROCE for Altium 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 Altium here for free.
So How Is Altium's ROCE Trending?
We like the trends that we're seeing from Altium. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 29%. Basically the business is earning more per dollar of capital invested and in addition to that, 65% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Altium has. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
On a separate note, we've found 2 warning signs for Altium you'll probably want to know about.
Altium is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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. 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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