What are the early trends we should look for to identify a stock that could 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 SAP (ETR:SAP), it didn't seem to tick all of these boxes.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for SAP:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.089 = €4.8b ÷ (€74b - €19b) (Based on the trailing twelve months to March 2023).
Thus, SAP has an ROCE of 8.9%. In absolute terms, that's a low return and it also under-performs the Software industry average of 12%.
View our latest analysis for SAP
In the above chart we have measured SAP's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for SAP.
What Does the ROCE Trend For SAP Tell Us?
On the surface, the trend of ROCE at SAP doesn't inspire confidence. Around five years ago the returns on capital were 16%, but since then they've fallen to 8.9%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
In Conclusion...
In summary, despite lower returns in the short term, we're encouraged to see that SAP is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 29% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
On a separate note, we've found 3 warning signs for SAP you'll probably want to know about.
While SAP may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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