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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. However, after briefly looking over the numbers, we don't think IDOX (LON:IDOX) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for IDOX, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.052 = UK£5.1m ÷ (UK£145m - UK£49m) (Based on the trailing twelve months to April 2020).
Therefore, IDOX has an ROCE of 5.2%. In absolute terms, that's a low return and it also under-performs the Software industry average of 8.6%.
In the above chart we have a measured IDOX'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 IDOX.
How Are Returns Trending?
Unfortunately, the trend isn't great with ROCE falling from 12% five years ago, while capital employed has grown 44%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with IDOX's earnings and if they change as a result from the capital raise.
Our Take On IDOX's ROCE
Bringing it all together, while we're somewhat encouraged by IDOX's reinvestment in its own business, we're aware that returns are shrinking. And investors may be recognizing these trends since the stock has only returned a total of 35% to shareholders over the last five years. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
If you want to know some of the risks facing IDOX we've found 4 warning signs (2 are concerning!) that you should be aware of before investing here.
While IDOX 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.
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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