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If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. So on that note, Magic Software Enterprises (NASDAQ:MGIC) looks quite promising in regards to its trends of return on capital.
Understanding 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. The formula for this calculation on Magic Software Enterprises is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = US$57m ÷ (US$537m - US$162m) (Based on the trailing twelve months to March 2024).
Therefore, Magic Software Enterprises has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 8.6% it's much better.
Check out our latest analysis for Magic Software Enterprises
In the above chart we have measured Magic Software Enterprises' 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 analyst report for Magic Software Enterprises .
What Can We Tell From Magic Software Enterprises' ROCE Trend?
Magic Software Enterprises has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 54% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 30% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.