99 Loyalty (ASX:99L) Is Experiencing Growth In Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Speaking of which, we noticed some great changes in 99 Loyalty's (ASX:99L) returns on capital, so let's have a look.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for 99 Loyalty:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.10 = CN¥36m ÷ (CN¥609m - CN¥260m) (Based on the trailing twelve months to June 2021).

Therefore, 99 Loyalty has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Software industry average of 11%.

Check out our latest analysis for 99 Loyalty

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how 99 Loyalty has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

We're pretty happy with how the ROCE has been trending at 99 Loyalty. The data shows that returns on capital have increased by 133% over the trailing five years. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Speaking of capital employed, the company is actually utilizing 28% less than it was five years ago, which can be indicative of a business that's improving its efficiency. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 43% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.

Our Take On 99 Loyalty's ROCE

In summary, it's great to see that 99 Loyalty has been able to turn things around and earn higher returns on lower amounts of capital. Astute investors may have an opportunity here because the stock has declined 68% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for 99 Loyalty (of which 1 doesn't sit too well with us!) that you should know about.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.