Stock Analysis

Returns On Capital Signal Tricky Times Ahead For Computer Modelling Group (TSE:CMG)

TSX:CMG
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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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.

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. The formula for this calculation on Computer Modelling Group is:

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

0.30 = CA$25m ÷ (CA$113m - CA$29m) (Based on the trailing twelve months to June 2021).

Thus, Computer Modelling Group has an ROCE of 30%. That's a fantastic return and not only that, it outpaces the average of 2.6% earned by companies in a similar industry.

Check out our latest analysis for Computer Modelling Group

roce
TSX:CMG Return on Capital Employed October 27th 2021

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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Computer Modelling Group Tell Us?

On the surface, the trend of ROCE at Computer Modelling Group doesn't inspire confidence. While it's comforting that the ROCE is high, five years ago it was 58%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

What We Can Learn From Computer Modelling Group's ROCE

In summary, we're somewhat concerned by Computer Modelling Group's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 30% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to continue researching Computer Modelling Group, you might be interested to know about the 3 warning signs that our analysis has discovered.

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.

Valuation is complex, but we're helping make it simple.

Find out whether Computer Modelling Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.

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