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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So on that note, eGain (NASDAQ:EGAN) looks quite promising in regards to its trends of return on capital.
What is Return On Capital Employed (ROCE)?
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 eGain, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = US$7.4m ÷ (US$94m - US$52m) (Based on the trailing twelve months to June 2020).
Therefore, eGain has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 9.2% 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For eGain Tell Us?
eGain has recently broken into profitability so their prior investments seem to be paying off. About five years ago the company was generating losses but things have turned around because it's now earning 18% on its capital. And unsurprisingly, like most companies trying to break into the black, eGain is utilizing 81% 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.
On a separate but related note, it's important to know that eGain has a current liabilities to total assets ratio of 56%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
What We Can Learn From eGain's ROCE
To the delight of most shareholders, eGain has now broken into profitability. And a remarkable 230% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if eGain can keep these trends up, it could have a bright future ahead.
One more thing: We've identified 3 warning signs with eGain (at least 1 which can't be ignored) , and understanding them would certainly be useful.
While eGain isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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