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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at MicroStrategy (NASDAQ:MSTR), it didn’t seem to tick all of these boxes.
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 MicroStrategy:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.035 = US$20m ÷ (US$833m – US$240m) (Based on the trailing twelve months to June 2020).
Therefore, MicroStrategy has an ROCE of 3.5%. In absolute terms, that’s a low return and it also under-performs the Software industry average of 9.2%.
Above you can see how the current ROCE for MicroStrategy 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.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at MicroStrategy, we didn’t gain much confidence. Over the last five years, returns on capital have decreased to 3.5% from 23% five years ago. However it looks like MicroStrategy might be reinvesting for long term growth because while capital employed has increased, the company’s sales haven’t changed much in the last 12 months. It’s worth keeping an eye on the company’s earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line On MicroStrategy’s ROCE
Bringing it all together, while we’re somewhat encouraged by MicroStrategy’s reinvestment in its own business, we’re aware that returns are shrinking. Since the stock has declined 27% over the last five years, investors may not be too optimistic on this trend improving either. All in all, the inherent trends aren’t typical of multi-baggers, so if that’s what you’re after, we think you might have more luck elsewhere.
On a separate note, we’ve found 1 warning sign for MicroStrategy you’ll probably want to know about.
While MicroStrategy 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.
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