Capital Allocation Trends At Converge Technology Solutions (TSE:CTS) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. However, after investigating Converge Technology Solutions (TSE:CTS), we don't think it's current trends fit the mold of a multi-bagger.

What Is 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 Converge Technology Solutions:

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

0.042 = CA$47m ÷ (CA$2.2b - CA$1.0b) (Based on the trailing twelve months to December 2023).

Thus, Converge Technology Solutions has an ROCE of 4.2%. Ultimately, that's a low return and it under-performs the IT industry average of 13%.

Check out our latest analysis for Converge Technology Solutions

In the above chart we have measured Converge Technology Solutions' 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 analyst report for Converge Technology Solutions .

What Can We Tell From Converge Technology Solutions' ROCE Trend?

On the surface, the trend of ROCE at Converge Technology Solutions doesn't inspire confidence. To be more specific, ROCE has fallen from 47% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Converge Technology Solutions has done well to pay down its current liabilities to 48% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Converge Technology Solutions. And long term investors must be optimistic going forward because the stock has returned a huge 352% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you're still interested in Converge Technology Solutions it's worth checking out our FREE intrinsic value approximation for CTS to see if it's trading at an attractive price in other respects.

While Converge Technology Solutions isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.