Technology One (ASX:TNE) Knows How To Allocate Capital Effectively

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. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, the ROCE of Technology One (ASX:TNE) looks great, so lets see what the trend can tell us.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Technology One:

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

0.43 = AU$99m ÷ (AU$455m - AU$228m) (Based on the trailing twelve months to September 2021).

Therefore, Technology One has an ROCE of 43%. In absolute terms that's a great return and it's even better than the Software industry average of 13%.

View our latest analysis for Technology One

Above you can see how the current ROCE for Technology One 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 Technology One.

What Does the ROCE Trend For Technology One Tell Us?

We like the trends that we're seeing from Technology One. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 43%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 41%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 50% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

The Bottom Line

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Technology One has. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

One more thing to note, we've identified 1 warning sign with Technology One and understanding it should be part of your investment process.

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.