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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Although, when we looked at i3 Verticals (NASDAQ:IIIV), it didn't seem to tick all of these boxes.
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. To calculate this metric for i3 Verticals, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.038 = US$12m ÷ (US$351m - US$31m) (Based on the trailing twelve months to March 2020).
Thus, i3 Verticals has an ROCE of 3.8%. Ultimately, that's a low return and it under-performs the IT industry average of 10.0%.
In the above chart we have a measured i3 Verticals' 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 Can We Tell From i3 Verticals' ROCE Trend?
We weren't thrilled with the trend because i3 Verticals' ROCE has reduced by 50% over the last three years, while the business employed 220% more capital. Usually this isn't ideal, but given i3 Verticals conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. i3 Verticals 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 On i3 Verticals' ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for i3 Verticals have fallen, meanwhile the business is employing more capital than it was three years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 21% return over the last year, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
i3 Verticals could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
While i3 Verticals 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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