PC Connection (NASDAQ:CNXN) Could Be Struggling To Allocate Capital
If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at PC Connection (NASDAQ:CNXN) and its ROCE trend, we weren't exactly thrilled.
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 PC Connection:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$85m ÷ (US$1.0b - US$293m) (Based on the trailing twelve months to September 2021).
So, PC Connection has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Electronic industry average of 10.0%.
View our latest analysis for PC Connection
In the above chart we have measured PC Connection's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering PC Connection here for free.
So How Is PC Connection's ROCE Trending?
When we looked at the ROCE trend at PC Connection, we didn't gain much confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 12%. However it looks like PC Connection might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line On PC Connection's ROCE
Bringing it all together, while we're somewhat encouraged by PC Connection's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 62% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Like most companies, PC Connection does come with some risks, and we've found 1 warning sign that you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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.
