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Simulations Plus' (NASDAQ:SLP) Returns On Capital Not Reflecting Well On The Business

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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Simulations Plus (NASDAQ:SLP), we don't think it's current trends fit the mold of a multi-bagger.

What is 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. The formula for this calculation on Simulations Plus is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.086 = US$15m ÷ (US$179m - US$7.3m) (Based on the trailing twelve months to May 2021).

Therefore, Simulations Plus has an ROCE of 8.6%. On its own that's a low return, but compared to the average of 5.4% generated by the Healthcare Services industry, it's much better.

See our latest analysis for Simulations Plus

roce
roce

In the above chart we have measured Simulations Plus' 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 Simulations Plus here for free.

What The Trend Of ROCE Can Tell Us

We weren't thrilled with the trend because Simulations Plus' ROCE has reduced by 68% over the last five years, while the business employed 593% more capital. That being said, Simulations Plus raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Simulations Plus probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

The Bottom Line

While returns have fallen for Simulations Plus in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 445% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

On a final note, we've found 2 warning signs for Simulations Plus that we think you should be aware of.

While Simulations Plus 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.