What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we’ll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company’s 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. Having said that, from a first glance at CRA International (NASDAQ:CRAI) we aren’t jumping out of our chairs at how returns are trending, but let’s have a deeper look.
Return On Capital Employed (ROCE): What is it?
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for CRA International, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.098 = US$34m ÷ (US$549m – US$198m) (Based on the trailing twelve months to June 2020).
Thus, CRA International has an ROCE of 9.8%. On its own that’s a low return on capital but it’s in line with the industry’s average returns of 9.9%.
Above you can see how the current ROCE for CRA International 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
There are better returns on capital out there than what we’re seeing at CRA International. The company has consistently earned 9.8% for the last five years, and the capital employed within the business has risen 52% in that time. 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.Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn’t increased to 36% of total assets, this reported ROCE would probably be less than9.8% because total capital employed would be higher.The 9.8% ROCE could be even lower if current liabilities weren’t 36% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.
Our Take On CRA International’s ROCE
As we’ve seen above, CRA International’s returns on capital haven’t increased but it is reinvesting in the business. Since the stock has gained an impressive 86% over the last five years, investors must think there’s better things to come. Ultimately, if the underlying trends persist, we wouldn’t hold our breath on it being a multi-bagger going forward.
On a final note, we’ve found 1 warning sign for CRA International that we think you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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