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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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating CLPS Incorporation (NASDAQ:CLPS), we don't think it's current trends fit the mold of a multi-bagger.
Understanding Return On Capital Employed (ROCE)
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 CLPS Incorporation, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$3.9m ÷ (US$66m - US$28m) (Based on the trailing twelve months to December 2020).
Thus, CLPS Incorporation has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the IT industry average of 12%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for CLPS Incorporation's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of CLPS Incorporation, check out these free graphs here.
What Can We Tell From CLPS Incorporation's ROCE Trend?
In terms of CLPS Incorporation's historical ROCE movements, the trend isn't fantastic. Over the last four years, returns on capital have decreased to 10% from 23% four years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, CLPS Incorporation has done well to pay down its current liabilities to 42% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 42% is still pretty high, so those risks are still somewhat prevalent.
The Key Takeaway
While returns have fallen for CLPS Incorporation in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. But since the stock has dived 72% in the last three years, there could be other drivers that are influencing the business' outlook. Therefore, we'd suggest researching the stock further to uncover more about the business.
One more thing to note, we've identified 3 warning signs with CLPS Incorporation and understanding them should be part of your investment process.
While CLPS Incorporation isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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