There Are Reasons To Feel Uneasy About Simulations Plus' (NASDAQ:SLP) Returns On Capital
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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Simulations Plus (NASDAQ:SLP) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
What Is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Simulations Plus, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.063 = US$11m ÷ (US$173m - US$6.0m) (Based on the trailing twelve months to February 2023).
Therefore, Simulations Plus has an ROCE of 6.3%. On its own that's a low return, but compared to the average of 5.3% generated by the Healthcare Services industry, it's much better.
Check out our latest analysis for Simulations Plus
In the above chart we have measured Simulations Plus' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Simulations Plus.
What Can We Tell From Simulations Plus' ROCE Trend?
On the surface, the trend of ROCE at Simulations Plus doesn't inspire confidence. Around five years ago the returns on capital were 29%, but since then they've fallen to 6.3%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
What We Can Learn From Simulations Plus' ROCE
Bringing it all together, while we're somewhat encouraged by Simulations Plus' reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 141% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Simulations Plus could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
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.
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