What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. So when we looked at Seven Principles (ETR:T3T1) and its trend of ROCE, we really liked what we saw.
Understanding 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. The formula for this calculation on Seven Principles is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = €1.3m ÷ (€23m - €10m) (Based on the trailing twelve months to June 2020).
So, Seven Principles has an ROCE of 10%. That's a relatively normal return on capital, and it's around the 8.6% generated by the IT industry.
View our latest analysis for Seven Principles
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Seven Principles, check out these free graphs here.
The Trend Of ROCE
We're delighted to see that Seven Principles is reaping rewards from its investments and has now broken into profitability. The company now earns 10% on its capital, because five years ago it was incurring losses. While returns have increased, the amount of capital employed by Seven Principles has remained flat over the period. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 45%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.
Our Take On Seven Principles' ROCE
To bring it all together, Seven Principles has done well to increase the returns it's generating from its capital employed. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 30% to shareholders. So with that in mind, we think the stock deserves further research.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Seven Principles (of which 1 is a bit unpleasant!) that you should know about.
While Seven Principles 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. 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:T3T1
Seven Principles
Provides digital business implementation support services in Germany and internationally.
Flawless balance sheet with solid track record.
