To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Although, when we looked at PSI Software (ETR:PSAN), it didn't seem to tick all of these boxes.
What is Return On Capital Employed (ROCE)?
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. The formula for this calculation on PSI Software is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.095 = €18m ÷ (€277m - €85m) (Based on the trailing twelve months to June 2021).
Thus, PSI Software has an ROCE of 9.5%. On its own, that's a low figure but it's around the 11% average generated by the Software industry.
See our latest analysis for PSI Software
In the above chart we have measured PSI Software's 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.
The Trend Of ROCE
The returns on capital haven't changed much for PSI Software in recent years. The company has consistently earned 9.5% for the last five years, and the capital employed within the business has risen 56% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
What We Can Learn From PSI Software's ROCE
As we've seen above, PSI Software's returns on capital haven't increased but it is reinvesting in the business. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 240% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Like most companies, PSI Software does come with some risks, and we've found 1 warning sign that you should be aware of.
While PSI Software may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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This article by Simply Wall St is general in nature. 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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About XTRA:PSAN
PSI Software
Develops and integrates software solutions and products for optimizing the flow of energy and materials for utilities and industry worldwide.
High growth potential and good value.
