- Oops!Something went wrong.Please try again later.
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. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Praemium (ASX:PPS), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
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. To calculate this metric for Praemium, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.056 = AU$5.4m ÷ (AU$118m - AU$21m) (Based on the trailing twelve months to December 2020).
Therefore, Praemium has an ROCE of 5.6%. Ultimately, that's a low return and it under-performs the Software industry average of 14%.
In the above chart we have measured Praemium'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.
So How Is Praemium's ROCE Trending?
In terms of Praemium's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.6% from 13% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that Praemium is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 152% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
On a final note, we've found 2 warning signs for Praemium that we think you should be aware of.
While Praemium 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.