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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Next Fifteen Communications Group (LON:NFC) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What is it?
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 Next Fifteen Communications Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.072 = UK£15m ÷ (UK£322m - UK£112m) (Based on the trailing twelve months to January 2021).
Thus, Next Fifteen Communications Group has an ROCE of 7.2%. In absolute terms, that's a low return and it also under-performs the Media industry average of 9.9%.
Above you can see how the current ROCE for Next Fifteen Communications Group 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 Next Fifteen Communications Group here for free.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Next Fifteen Communications Group, we didn't gain much confidence. Around five years ago the returns on capital were 13%, but since then they've fallen to 7.2%. 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'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.
Our Take On Next Fifteen Communications Group's ROCE
In summary, Next Fifteen Communications Group is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 252% 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.
Like most companies, Next Fifteen Communications Group does come with some risks, and we've found 2 warning signs that you should be aware of.
While Next Fifteen Communications Group 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.
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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