esoft systems A/S (CPH:ESOFT): Assessing Capital Returns

This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in esoft systems A/S (CPH:ESOFT).

esoft systems stock represents an ownership share in the company. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. Your return is tied to ESOFT’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. Thus, to understand how your money can grow by investing in esoft systems, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).

View our latest analysis for esoft systems

ROCE: Explanation and Calculation

As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. To determine esoft systems’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). ESOFT’s ROCE is calculated below:

ROCE Calculation for ESOFT

Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)

Capital Employed = (Total Assets – Current Liabilities)

∴ ROCE = ø6.7m ÷ (ø47m – ø6.1m) = 17%

The calculation above shows that ESOFT’s earnings were 17% of capital employed. A good ROCE hurdle you should aim for in your investments is 15%, which is exceeded by ESOFT and means the company creates a solid amount of earnings on capital employed. If this can be sustained with good reinvestment opportunities or dividend distributions your capital has the potential to compound over time.

CPSE:ESOFT Last Perf November 23rd 18
CPSE:ESOFT Last Perf November 23rd 18

A deeper look

The encouraging ROCE is good news for esoft systems investors if the company is able to maintain strong earnings and control their capital needs. But if this doesn’t occur, ESOFT’s ROCE may deteriorate, in which case your money is better invested elsewhere. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. If you go back three years, you’ll find that ESOFT’s ROCE has decreased from 21%. Conversely, the movement in the earnings variable shows a jump from ø2.9m to ø6.7m albeit capital employed has increased by a relatively larger volume due to an increase in total assets and decrease in current liabilities (less borrowed money) , which suggests investor’s ROCE has fallen because the company requires more capital to create earnings despite the previous growth in EBT.

Next Steps

ROCE for ESOFT investors has declined in the last few years, however, the company still remains an attractive candidate that is capable of producing solid capital returns and a potentially strong return on investment. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. Without considering these fundamentals, you cannot be sure if the downward path is a signal to run, or just a blip in an otherwise solid return profile. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate ESOFT or other alternatives.

  1. Future Outlook: What are well-informed industry analysts predicting for ESOFT’s future growth? Take a look at our free research report of analyst consensus for ESOFT’s outlook.
  2. Valuation: What is ESOFT worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether ESOFT is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.