If you’re not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. However, after investigating Endava (NYSE:DAVA), we don’t think it’s current trends fit the mold of a multi-bagger.
Understanding 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 Endava:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.093 = UK£24m ÷ (UK£337m – UK£81m) (Based on the trailing twelve months to March 2020).
Therefore, Endava has an ROCE of 9.3%. In absolute terms, that’s a low return but it’s around the IT industry average of 10%.
Above you can see how the current ROCE for Endava compares to its prior returns on capital, but there’s only so much you can tell from the past. If you’re interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
The trend of ROCE doesn’t look fantastic because it’s fallen from 55% five years ago, while the business’s capital employed increased by 815%. That being said, Endava raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It’s unlikely that all of the funds raised have been put to work yet, so as a consequence Endava might not have received a full period of earnings contribution from it.On a related note, Endava has decreased its current liabilities to 24% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it’s own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line
While returns have fallen for Endava in recent times, we’re encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 48% over the last year, it would appear that investors are upbeat about the future. So should these growth trends continue, we’d be optimistic on the stock going forward.
If you want to continue researching Endava, you might be interested to know about the 1 warning sign that our analysis has discovered.
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.
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