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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. With that in mind, the ROCE of Enghouse Systems (TSE:ENGH) looks great, so lets see what the trend can tell us.
Understanding 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. The formula for this calculation on Enghouse Systems is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.26 = CA$127m ÷ (CA$793m - CA$310m) (Based on the trailing twelve months to January 2021).
Therefore, Enghouse Systems has an ROCE of 26%. That's a fantastic return and not only that, it outpaces the average of 10% earned by companies in a similar industry.
Above you can see how the current ROCE for Enghouse Systems 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 Enghouse Systems here for free.
What Does the ROCE Trend For Enghouse Systems Tell Us?
We like the trends that we're seeing from Enghouse Systems. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 26%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 67%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Bottom Line On Enghouse Systems' ROCE
In summary, it's great to see that Enghouse Systems can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Since the stock has returned a staggering 133% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing: We've identified 2 warning signs with Enghouse Systems (at least 1 which is concerning) , and understanding these would certainly be useful.
Enghouse Systems is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
This article by Simply Wall St is general in nature. 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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