If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. That's why when we briefly looked at Technology One's (ASX:TNE) ROCE trend, we were very happy with what we saw.
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 Technology One, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.45 = AU$104m ÷ (AU$432m – AU$199m) (Based on the trailing twelve months to March 2022).
Thus, Technology One has an ROCE of 45%. In absolute terms that's a great return and it's even better than the Software industry average of 11%.
Check out our latest analysis for Technology One
In the above chart we have measured Technology One'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 Technology One.
In terms of Technology One's history of ROCE, it's quite impressive. The company has employed 64% more capital in the last five years, and the returns on that capital have remained stable at 45%. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.
On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 46% of total assets, this reported ROCE would probably be less than45% because total capital employed would be higher.The 45% ROCE could be even lower if current liabilities weren't 46% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.
Technology One has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. Therefore it's no surprise that shareholders have earned a respectable 92% return if they held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.
Technology One is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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.
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