Enghouse Systems (TSE:ENGH) May Have Issues Allocating Its Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Enghouse Systems (TSE:ENGH) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Enghouse Systems is:

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

0.15 = CA$85m ÷ (CA$746m - CA$185m) (Based on the trailing twelve months to July 2023).

Therefore, Enghouse Systems has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 8.9% it's much better.

View our latest analysis for Enghouse Systems

In the above chart we have measured Enghouse Systems' 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.

So How Is Enghouse Systems' ROCE Trending?

In terms of Enghouse Systems' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 15% from 19% 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 may take some time before the company starts to see any change in earnings from these investments.

In Conclusion...

To conclude, we've found that Enghouse Systems is reinvesting in the business, but returns have been falling. Additionally, the stock's total return to shareholders over the last five years has been flat, which isn't too surprising. Therefore based on the analysis done in this article, we don't think Enghouse Systems has the makings of a multi-bagger.

Enghouse Systems could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.