Stock Analysis

Computer Modelling Group's (TSE:CMG) Returns On Capital Not Reflecting Well On The Business

TSX:CMG
Source: Shutterstock

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So while Computer Modelling Group (TSE:CMG) has a high ROCE right now, lets see what we can decipher from how returns are changing.

Understanding 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. Analysts use this formula to calculate it for Computer Modelling Group:

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

0.30 = CA$26m ÷ (CA$125m - CA$39m) (Based on the trailing twelve months to March 2022).

Therefore, Computer Modelling Group has an ROCE of 30%. That's a fantastic return and not only that, it outpaces the average of 4.7% earned by companies in a similar industry.

Check out our latest analysis for Computer Modelling Group

roce
TSX:CMG Return on Capital Employed May 26th 2022

In the above chart we have measured Computer Modelling Group'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 Computer Modelling Group.

How Are Returns Trending?

In terms of Computer Modelling Group's historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 55% where it was five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Computer Modelling Group has done well to pay down its current liabilities to 31% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Computer Modelling Group's ROCE

To conclude, we've found that Computer Modelling Group is reinvesting in the business, but returns have been falling. And in the last five years, the stock has given away 42% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

On a final note, we've found 1 warning sign for Computer Modelling Group that we think 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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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

About TSX:CMG

Computer Modelling Group

A software and consulting technology company, engages in the development and licensing of reservoir simulation and seismic interpretation software and related services.

Very undervalued with excellent balance sheet.

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