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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at eGain (NASDAQ:EGAN) and its trend of ROCE, we really liked what we saw.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on eGain is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$5.7m ÷ (US$109m - US$53m) (Based on the trailing twelve months to September 2021).
Thus, eGain has an ROCE of 10%. That's a relatively normal return on capital, and it's around the 11% generated by the Software industry.
In the above chart we have measured eGain's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering eGain here for free.
What Does the ROCE Trend For eGain Tell Us?
We're delighted to see that eGain is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it's now earning 10% on its capital. And unsurprisingly, like most companies trying to break into the black, eGain is utilizing 303% more capital than it was five years ago. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
One more thing to note, eGain has decreased current liabilities to 49% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. This tells us that eGain has grown its returns without a reliance on increasing their current liabilities, which we're very happy with. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.
The Bottom Line On eGain's ROCE
In summary, it's great to see that eGain has managed to break into profitability and is continuing to reinvest in its business. And a remarkable 390% total return over the last five years tells us that investors are expecting more good things to come in the future. Therefore, we think it would be worth your time to check if these trends are going to continue.
One more thing: We've identified 2 warning signs with eGain (at least 1 which shouldn't be ignored) , and understanding these would certainly be useful.
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.
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.