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. Ultimately, this demonstrates that it’s a business that is reinvesting profits at increasing rates of return. Although, when we looked at First Derivatives (LON:FDP), it didn’t seem to tick all of these boxes.
What is Return On Capital Employed (ROCE)?
For those who don’t know, ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for First Derivatives:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.065 = UK£18m ÷ (UK£350m – UK£70m) (Based on the trailing twelve months to February 2021).
So, First Derivatives has an ROCE of 6.5%. In absolute terms, that’s a low return and it also under-performs the Software industry average of 9.1%.
Above you can see how the current ROCE for First Derivatives compares to its prior returns on capital, but there’s only so much you can tell from the past. If you’d like to see what analysts are forecasting going forward, you should check out our free report for First Derivatives.
How Are Returns Trending?
In terms of First Derivatives’ historical ROCE trend, it doesn’t exactly demand attention. Over the past five years, ROCE has remained relatively flat at around 6.5% and the business has deployed 51% more capital into its operations. This poor ROCE doesn’t inspire confidence right now, and with the increase in capital employed, it’s evident that the business isn’t deploying the funds into high return investments.
The Bottom Line
As we’ve seen above, First Derivatives’ returns on capital haven’t increased but it is reinvesting in the business. And with the stock having returned a mere 29% in the last five years to shareholders, you could argue that they’re aware of these lackluster trends. As a result, if you’re hunting for a multi-bagger, we think you’d have more luck elsewhere.
On a separate note, we’ve found 2 warning signs for First Derivatives you’ll probably want to know about.
While First Derivatives isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.