To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at Optiva (TSE:OPT) so let's look a bit deeper.
Return On Capital Employed (ROCE): What Is It?
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. To calculate this metric for Optiva, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = US$7.1m ÷ (US$79m - US$16m) (Based on the trailing twelve months to March 2023).
So, Optiva has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 8.6% generated by the Software industry.
View our latest analysis for Optiva
Above you can see how the current ROCE for Optiva compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Optiva here for free.
How Are Returns Trending?
It's great to see that Optiva has started to generate some pre-tax earnings from prior investments. Historically the company was generating losses but as we can see from the latest figures referenced above, they're now earning 11% on their capital employed. Additionally, the business is utilizing 29% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.
One more thing to note, Optiva has decreased current liabilities to 21% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
The Bottom Line
From what we've seen above, Optiva has managed to increase it's returns on capital all the while reducing it's capital base. However the stock is down a substantial 89% in the last five years so there could be other areas of the business hurting its prospects. Still, it's worth doing some further research to see if the trends will continue into the future.
If you want to know some of the risks facing Optiva we've found 3 warning signs (1 is significant!) that you should be aware of before investing here.
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.
About TSX:OPT
Optiva
Provides cloud-native monetization and business support systems products to communication service providers (CSP) in Europe, the Middle East, Africa, North America, Latin America, the Caribbean, Asia, and the Pacific Rim.
Undervalued low.