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There are a few key trends to look for if we want to identify the next multi-bagger. 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. So when we looked at Seven Principles (ETR:T3T1) and its trend of ROCE, we really liked what we saw.
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 Seven Principles, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.047 = €805k ÷ (€22m - €5.2m) (Based on the trailing twelve months to June 2024).
Therefore, Seven Principles has an ROCE of 4.7%. In absolute terms, that's a low return and it also under-performs the IT industry average of 12%.
Check out our latest analysis for Seven Principles
Historical performance is a great place to start when researching a stock so above you can see the gauge for Seven Principles' 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 Seven Principles.
What Can We Tell From Seven Principles' ROCE Trend?
We're delighted to see that Seven Principles is reaping rewards from its investments and has now broken into profitability. The company now earns 4.7% on its capital, because five years ago it was incurring losses. While returns have increased, the amount of capital employed by Seven Principles has remained flat over the period. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 23%, 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.
The Bottom Line
As discussed above, Seven Principles appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Astute investors may have an opportunity here because the stock has declined 50% in the last five years. That being the case, research into the company's current valuation metrics and future prospects seems fitting.