What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 Softchoice (TSE:SFTC) 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. The formula for this calculation on Softchoice is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = US$39m ÷ (US$591m - US$381m) (Based on the trailing twelve months to September 2022).
So, Softchoice has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 9.9% it's much better.
View our latest analysis for Softchoice
In the above chart we have measured Softchoice's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Softchoice here for free.
What Can We Tell From Softchoice's ROCE Trend?
Softchoice's ROCE growth is quite impressive. The figures show that over the last two years, ROCE has grown 153% whilst employing roughly the same amount of capital. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
Another thing to note, Softchoice has a high ratio of current liabilities to total assets of 64%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
To bring it all together, Softchoice has done well to increase the returns it's generating from its capital employed. Astute investors may have an opportunity here because the stock has declined 25% in the last year. With that in mind, we believe the promising trends warrant this stock for further investigation.
One more thing to note, we've identified 2 warning signs with Softchoice and understanding them should be part of your investment process.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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