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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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in IDOX's (LON:IDOX) returns on capital, so let's have a look.
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Return On Capital Employed (ROCE): What Is It?
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. The formula for this calculation on IDOX is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = UK£10m ÷ (UK£146m - UK£47m) (Based on the trailing twelve months to October 2024).
Thus, IDOX has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Software industry average of 12%.
Check out our latest analysis for IDOX
Above you can see how the current ROCE for IDOX compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering IDOX for free.
What The Trend Of ROCE Can Tell Us
The trends we've noticed at IDOX are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 10%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 59%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 32%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
In Conclusion...
In summary, it's great to see that IDOX can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Since the stock has only returned 38% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.