What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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 when we looked at Pason Systems (TSE:PSI) and its trend of ROCE, we really liked what we saw.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Pason Systems:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = CA$37m ÷ (CA$380m - CA$42m) (Based on the trailing twelve months to December 2021).
Thus, Pason Systems has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 7.6% generated by the Energy Services industry.
In the above chart we have measured Pason Systems' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Pason Systems here for free.
What Does the ROCE Trend For Pason Systems Tell Us?
Pason Systems has broken into the black (profitability) and we're sure it's a sight for sore eyes. While the business was unprofitable in the past, it's now turned things around and is earning 11% on its capital. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.
What We Can Learn From Pason Systems' ROCE
As discussed above, Pason Systems appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. So researching this company further and determining whether or not these trends will continue seems justified.
If you want to continue researching Pason Systems, you might be interested to know about the 3 warning signs that our analysis has discovered.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.
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