What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Magic Software Enterprises (NASDAQ:MGIC) so let's look a bit deeper.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Magic Software Enterprises, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = US$59m ÷ (US$494m - US$107m) (Based on the trailing twelve months to June 2022).
So, Magic Software Enterprises has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 10% it's much better.
Above you can see how the current ROCE for Magic Software Enterprises compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Magic Software Enterprises here for free.
What Does the ROCE Trend For Magic Software Enterprises Tell Us?
The trends we've noticed at Magic Software Enterprises are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 15%. Basically the business is earning more per dollar of capital invested and in addition to that, 32% more capital is being employed now too. So we're very much inspired by what we're seeing at Magic Software Enterprises thanks to its ability to profitably reinvest capital.
What We Can Learn From Magic Software Enterprises' ROCE
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Magic Software Enterprises has. And a remarkable 159% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Magic Software Enterprises does have some risks though, and we've spotted 1 warning sign for Magic Software Enterprises that you might be interested in.
While Magic Software Enterprises isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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