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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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. So on that note, MSL Solutions (ASX:MSL) looks quite promising in regards to its trends of return on capital.
What Is Return On Capital Employed (ROCE)?
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 MSL Solutions, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.043 = AU$1.4m ÷ (AU$46m - AU$12m) (Based on the trailing twelve months to December 2021).
So, MSL Solutions has an ROCE of 4.3%. Ultimately, that's a low return and it under-performs the Software industry average of 13%.
Above you can see how the current ROCE for MSL Solutions compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for MSL Solutions.
The Trend Of ROCE
We're delighted to see that MSL Solutions is reaping rewards from its investments and has now broken into profitability. Historically the company was generating losses but as we can see from the latest figures referenced above, they're now earning 4.3% on their capital employed. Additionally, the business is utilizing 34% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. This could potentially mean that the company is selling some of its assets.
The Bottom Line On MSL Solutions' ROCE
From what we've seen above, MSL Solutions has managed to increase it's returns on capital all the while reducing it's capital base. Given the stock has declined 42% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.
Like most companies, MSL Solutions does come with some risks, and we've found 3 warning signs that you should be aware of.
While MSL Solutions may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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