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What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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 Simulations Plus (NASDAQ:SLP), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Simulations Plus is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = US$12m ÷ (US$181m - US$9.6m) (Based on the trailing twelve months to November 2021).
Therefore, Simulations Plus has an ROCE of 7.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.6%.
See our latest analysis for Simulations Plus
Above you can see how the current ROCE for Simulations Plus compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Simulations Plus.
How Are Returns Trending?
In terms of Simulations Plus' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 28% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
Our Take On Simulations Plus' ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Simulations Plus is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 307% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
Simulations Plus does have some risks though, and we've spotted 1 warning sign for Simulations Plus that you might be interested in.