Fabasoft (ETR:FAA) Knows How To Allocate Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. That's why when we briefly looked at Fabasoft's (ETR:FAA) ROCE trend, we were very happy with what we saw.

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. To calculate this metric for Fabasoft, this is the formula:

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

0.29 = €11m ÷ (€69m - €31m) (Based on the trailing twelve months to June 2022).

Thus, Fabasoft has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Software industry average of 14%.

See our latest analysis for Fabasoft

In the above chart we have measured Fabasoft's 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 Fabasoft here for free.

The Trend Of ROCE

It's hard not to be impressed by Fabasoft's returns on capital. The company has employed 133% more capital in the last five years, and the returns on that capital have remained stable at 29%. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

On a separate but related note, it's important to know that Fabasoft has a current liabilities to total assets ratio of 45%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Fabasoft's ROCE

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. Therefore it's no surprise that shareholders have earned a respectable 65% return if they held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

Like most companies, Fabasoft does come with some risks, and we've found 1 warning sign that you should be aware of.

Fabasoft is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.