Returns On Capital At Open Text (NASDAQ:OTEX) Have Stalled
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. 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. However, after investigating Open Text (NASDAQ:OTEX), we don't think it's current trends fit the mold of a multi-bagger.
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. To calculate this metric for Open Text, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.087 = US$728m ÷ (US$9.5b - US$1.2b) (Based on the trailing twelve months to September 2021).
Therefore, Open Text has an ROCE of 8.7%. On its own, that's a low figure but it's around the 11% average generated by the Software industry.
View our latest analysis for Open Text
Above you can see how the current ROCE for Open Text compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
The returns on capital haven't changed much for Open Text in recent years. Over the past five years, ROCE has remained relatively flat at around 8.7% and the business has deployed 54% more capital into its operations. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
Our Take On Open Text's ROCE
In conclusion, Open Text has been investing more capital into the business, but returns on that capital haven't increased. Since the stock has gained an impressive 66% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Open Text does have some risks though, and we've spotted 3 warning signs for Open Text that you might be interested in.
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.
