Here's What To Make Of IT Link's (EPA:ALITL) Returns On Capital

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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. That's why when we briefly looked at IT Link's (EPA:ALITL) ROCE trend, we were pretty happy with what we saw.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on IT Link is:

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

0.15 = €3.2m ÷ (€41m - €20m) (Based on the trailing twelve months to June 2020).

Thus, IT Link has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 8.0% it's much better.

Check out our latest analysis for IT Link

Above you can see how the current ROCE for IT Link 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 IT Link here for free.

What The Trend Of ROCE Can Tell Us

The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has employed 175% more capital in the last five years, and the returns on that capital have remained stable at 15%. Since 15% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 50% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously. Although because current liabilities are still 50%, some of that risk is still prevalent.

In Conclusion...

The main thing to remember is that IT Link has proven its ability to continually reinvest at respectable rates of return. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

One more thing: We've identified 3 warning signs with IT Link (at least 2 which don't sit too well with us) , and understanding these would certainly be useful.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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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