Here's What To Make Of Iress' (ASX:IRE) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Iress (ASX:IRE) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

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. To calculate this metric for Iress, this is the formula:

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

0.10 = AU$92m ÷ (AU$1.0b - AU$102m) (Based on the trailing twelve months to December 2020).

So, Iress has an ROCE of 10%. In isolation, that's a pretty standard return but against the Software industry average of 14%, it's not as good.

View our latest analysis for Iress

In the above chart we have measured Iress' 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 The Trend Of ROCE Can Tell Us

The trend of ROCE doesn't look fantastic because it's fallen from 14% five years ago, while the business's capital employed increased by 56%. That being said, Iress 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 Iress might not have received a full period of earnings contribution from it. Additionally, we found that Iress' most recent EBIT figure is around the same as the prior year, so we'd attribute the drop in ROCE mostly to the capital raise.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Iress' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly then, the total return to shareholders over the last five years has been flat. Therefore based on the analysis done in this article, we don't think Iress has the makings of a multi-bagger.

One final note, you should learn about the 2 warning signs we've spotted with Iress (including 1 which is potentially serious) .

While Iress isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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