What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 Objective (ASX:OCL), they do have a high ROCE, but we weren’t exactly elated from how returns are trending.
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. Analysts use this formula to calculate it for Objective:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.30 = AU$13m ÷ (AU$79m – AU$37m) (Based on the trailing twelve months to December 2019).
Thus, Objective has an ROCE of 30%. That’s a fantastic return and not only that, it outpaces the average of 16% earned by companies in a similar industry.
In the above chart we have a measured Objective’s 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 report on analyst forecasts for the company.
What Does the ROCE Trend For Objective Tell Us?
On the surface, the trend of ROCE at Objective doesn’t inspire confidence. Historically returns on capital were even higher at 47%, but they have dropped over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.On a side note, Objective has done well to pay down its current liabilities to 47% of total assets. That could partly explain why the ROCE has dropped. What’s more, this can reduce some aspects of risk to the business because now the company’s suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business’ efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 47% is still pretty high, so those risks are still somewhat prevalent.
Our Take On Objective’s ROCE
While returns have fallen for Objective in recent times, we’re encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 509% to shareholders in the last five years. So should these growth trends continue, we’d be optimistic on the stock going forward.
If you want to continue researching Objective, you might be interested to know about the 1 warning sign that our analysis has discovered.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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