Will The ROCE Trend At NEXTDC (ASX:NXT) Continue?

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, NEXTDC (ASX:NXT) looks quite promising in regards to its trends of return on capital.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on NEXTDC is:

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

0.015 = AU$34m ÷ (AU$2.7b - AU$379m) (Based on the trailing twelve months to June 2020).

So, NEXTDC has an ROCE of 1.5%. In absolute terms, that's a low return and it also under-performs the IT industry average of 9.8%.

Check out our latest analysis for NEXTDC

Above you can see how the current ROCE for NEXTDC compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for NEXTDC.

What Can We Tell From NEXTDC's ROCE Trend?

We're delighted to see that NEXTDC is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 1.5% which is a sight for sore eyes. In addition to that, NEXTDC is employing 696% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

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 14% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line On NEXTDC's ROCE

Long story short, we're delighted to see that NEXTDC's reinvestment activities have paid off and the company is now profitable. And a remarkable 378% total return over the last five years tells us that investors are expecting more good things to come in the future. Therefore, we think it would be worth your time to check if these trends are going to continue.

On a separate note, we've found 1 warning sign for NEXTDC you'll probably want to know about.

While NEXTDC 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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