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. 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. Speaking of which, we noticed some great changes in Crexendo's (NASDAQ:CXDO) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Crexendo, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.064 = US$1.2m ÷ (US$22m - US$3.7m) (Based on the trailing twelve months to September 2020).
Thus, Crexendo has an ROCE of 6.4%. Ultimately, that's a low return and it under-performs the IT industry average of 9.5%.
In the above chart we have measured Crexendo's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Crexendo.
How Are Returns Trending?
The fact that Crexendo is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 6.4% which is a sight for sore eyes. In addition to that, Crexendo is employing 507% more capital than previously which is expected of a company that's trying to break into profitability. 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.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 17%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. This tells us that Crexendo has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.
Our Take On Crexendo's ROCE
To the delight of most shareholders, Crexendo has now broken into profitability. Since the stock has returned a staggering 276% 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.
Crexendo does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is potentially serious...
While Crexendo 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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