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What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Tekcapital's (LON:TEK) returns on capital, so let's have a look.
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. Analysts use this formula to calculate it for Tekcapital:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = US$7.7m ÷ (US$33m - US$403k) (Based on the trailing twelve months to November 2020).
Therefore, Tekcapital has an ROCE of 23%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Tekcapital, check out these free graphs here.
What Does the ROCE Trend For Tekcapital Tell Us?
The fact that Tekcapital is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 23% which is a sight for sore eyes. In addition to that, Tekcapital is employing 782% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
Overall, Tekcapital gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Astute investors may have an opportunity here because the stock has declined 66% in the last five years. So researching this company further and determining whether or not these trends will continue seems justified.
Tekcapital does come with some risks though, we found 4 warning signs in our investment analysis, and 2 of those are significant...
High returns are a key ingredient to strong performance, so check out our free list ofstocks 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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