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There are a few key trends to look for if we want to identify the next multi-bagger. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 while Tekcapital (LON:TEK) has a high ROCE right now, lets see what we can decipher from how returns are changing.
What Is Return On Capital Employed (ROCE)?
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 Tekcapital, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = US$14m ÷ (US$70m - US$546k) (Based on the trailing twelve months to June 2024).
Therefore, Tekcapital has an ROCE of 20%. In absolute terms that's a very respectable return and compared to the Professional Services industry average of 17% it's pretty much on par.
See our latest analysis for Tekcapital
Historical performance is a great place to start when researching a stock so above you can see the gauge for Tekcapital's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Tekcapital.
What The Trend Of ROCE Can Tell Us
We weren't thrilled with the trend because Tekcapital's ROCE has reduced by 49% over the last five years, while the business employed 230% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Tekcapital might not have received a full period of earnings contribution from it.
What We Can Learn From Tekcapital's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Tekcapital. These trends are starting to be recognized by investors since the stock has delivered a 8.9% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.
Tekcapital does have some risks, we noticed 5 warning signs (and 2 which make us uncomfortable) we think you should know about.