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Constellation Software (TSE:CSU) Knows How to Allocate Capital

Simply Wall St
·3 min read

What trends should we look for it we want to identify stocks that can multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So, when we ran our eye over Constellation Software's (TSE:CSU) trend of ROCE, we really liked what we saw.

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 capital employed in its business. Analysts use this formula to calculate it for Constellation Software:

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

0.30 = US$623m ÷ (US$3.9b - US$1.8b) (Based on the trailing twelve months to September 2020).

Therefore, Constellation Software has an ROCE of 30%. That's a fantastic return and not only that, it outpaces the average of 18% earned by companies in a similar industry.

View our latest analysis for Constellation Software

roce
roce

In the above chart we have measured Constellation Software's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Constellation Software Tell Us?

Constellation Software deserves to be commended in regards to it's returns. The company has consistently earned 30% for the last five years, and the capital employed within the business has risen 141% in that time. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.

Another thing to note, Constellation Software has a high ratio of current liabilities to total assets of 47%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On Constellation Software's ROCE

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. On top of that, the stock has rewarded shareholders with a remarkable 184% return to those who've held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.

One more thing, we've spotted 2 warning signs facing Constellation Software that you might find interesting.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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.

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