The Return Trends At Novabase S.G.P.S (FRA:NVQ) Look Promising

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. So on that note, Novabase S.G.P.S (FRA:NVQ) looks quite promising in regards to its trends of return on capital.

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. Analysts use this formula to calculate it for Novabase S.G.P.S:

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

0.16 = €11m ÷ (€141m - €72m) (Based on the trailing twelve months to June 2023).

So, Novabase S.G.P.S has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the IT industry average of 9.9% it's much better.

View 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

Novabase S.G.P.S has not disappointed in regards to ROCE growth. We found that the returns on capital employed over the last five years have risen by 40%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Interestingly, the business may be becoming more efficient because it's applying 32% less capital than it was five years ago. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 51% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

What We Can Learn From Novabase S.G.P.S' ROCE

In the end, Novabase S.G.P.S has proven it's capital allocation skills are good with those higher returns from less amount of capital. Since the stock has returned a staggering 181% to shareholders over the last five years, it looks like investors are recognizing these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

One more thing to note, we've identified 2 warning signs with Novabase S.G.P.S and understanding these should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.