Capital Investment Trends At Technology One (ASX:TNE) Look Strong

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'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Ergo, when we looked at the ROCE trends at Technology One (ASX:TNE), we liked what we saw.

Understanding 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. To calculate this metric for Technology One, this is the formula:

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

0.40 = AU$115m ÷ (AU$505m - AU$222m) (Based on the trailing twelve months to March 2023).

So, Technology One has an ROCE of 40%. In absolute terms that's a great return and it's even better than the Software industry average of 12%.

See our latest analysis for Technology One

In the above chart we have measured Technology One's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Technology One.

The Trend Of ROCE

It's hard not to be impressed by Technology One's returns on capital. The company has consistently earned 40% for the last five years, and the capital employed within the business has risen 90% in that time. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

On a separate but related note, it's important to know that Technology One has a current liabilities to total assets ratio of 44%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Technology One's ROCE

In short, we'd argue Technology One has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. And long term investors would be thrilled with the 243% return they've received over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

Like most companies, Technology One does come with some risks, and we've found 1 warning sign that you should be aware of.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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.