Praemium (ASX:PPS) Is Reinvesting At Lower Rates Of Return

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Praemium (ASX:PPS) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is Return On Capital Employed (ROCE)?

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 Praemium, this is the formula:

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

0.056 = AU$5.4m ÷ (AU$118m - AU$21m) (Based on the trailing twelve months to December 2020).

So, Praemium has an ROCE of 5.6%. Ultimately, that's a low return and it under-performs the Software industry average of 14%.

See our latest analysis for Praemium

Above you can see how the current ROCE for Praemium 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.

How Are Returns Trending?

On the surface, the trend of ROCE at Praemium doesn't inspire confidence. To be more specific, ROCE has fallen from 13% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line On Praemium's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Praemium. And the stock has done incredibly well with a 144% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One more thing, we've spotted 1 warning sign facing Praemium that you might find interesting.

While Praemium 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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