Here's What To Make Of Novabase S.G.P.S' (FRA:NVQ) Decelerating Rates Of Return

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at Novabase S.G.P.S (FRA:NVQ) and its ROCE trend, we weren't exactly thrilled.

What is 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 Novabase S.G.P.S is:

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

0.077 = €7.5m ÷ (€170m - €72m) (Based on the trailing twelve months to December 2020).

Thus, Novabase S.G.P.S has an ROCE of 7.7%. In absolute terms, that's a low return and it also under-performs the IT industry average of 9.6%.

See our latest analysis for Novabase S.G.P.S

Above you can see how the current ROCE for Novabase S.G.P.S 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 Novabase S.G.P.S here for free.

What The Trend Of ROCE Can Tell Us

Things have been pretty stable at Novabase S.G.P.S, with its capital employed and returns on that capital staying somewhat the same for the last five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So don't be surprised if Novabase S.G.P.S doesn't end up being a multi-bagger in a few years time. On top of that you'll notice that Novabase S.G.P.S has been paying out a large portion (133%) of earnings in the form of dividends to shareholders. Most shareholders probably know this and own the stock for its dividend.

Another thing to note, Novabase S.G.P.S has a high ratio of current liabilities to total assets of 43%. 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.

In Conclusion...

In summary, Novabase S.G.P.S isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Yet to long term shareholders the stock has gifted them an incredible 231% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you want to continue researching Novabase S.G.P.S, you might be interested to know about the 1 warning sign that our analysis has discovered.

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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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