This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between esoft systems a/s (CPH:ESOFT)’s return fundamentals and stock market performance.
Purchasing esoft systems gives you an ownership stake 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. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. 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).
esoft systems’s Return On Capital Employed
Choosing to invest in esoft systems comes at the cost of investing in another potentially favourable company. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if esoft systems is good at growing investor capital. 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 = ø6.69m ÷ (ø46.96m – ø6.14m) = 16.40%
ESOFT’s 16.40% ROCE means that for every DKK100 you invest, the company creates DKK16.4. This shows esoft systems provides a favourable return to capital holders, which beats the 15% ROCE that is typically considered to be a strong benchmark. As a result, if ESOFT is clever with their reinvestments or dividend payments, investors can grow their capital at an attractive rate over time.
Does this mean I should invest?
Although esoft systems is in a favourable position, you should know that this could change if the company is unable to maintain a strong ROCE above the benchmark, which will depend on the behaviour of the underlying variables (EBT and capital employed). Therefore, investors need to be confident in the trend of the inputs in the formula above, so that esoft systems will continue the solid returns. If you go back three years, you’ll find that ESOFT’s ROCE has decreased from 16.74%. With this, the current earnings of ø6.69m improved from ø2.90m however capital employed has improved by a proportionally greater amount as a result of 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.
Although esoft systems’s ROCE has decreased over the past few years, the company still remains an attractive candidate that is capable of producing solid capital returns and a potentially strong return on investment. It is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as future prospects and valuation. It’s important to account for these factors because 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.
- 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.
- 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.
- 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 firstname.lastname@example.org.