Axway Software (EPA:AXW) May Have Issues Allocating Its Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Although, when we looked at Axway Software (EPA:AXW), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Axway Software, this is the formula:

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

0.04 = €18m ÷ (€559m - €121m) (Based on the trailing twelve months to December 2020).

Therefore, Axway Software has an ROCE of 4.0%. In absolute terms, that's a low return and it also under-performs the Software industry average of 10%.

View our latest analysis for Axway Software

In the above chart we have measured Axway Software's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Axway Software.

What The Trend Of ROCE Can Tell Us

In terms of Axway Software's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 10%, but since then they've fallen to 4.0%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

Our Take On Axway Software's ROCE

Bringing it all together, while we're somewhat encouraged by Axway Software's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 60% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Like most companies, Axway Software does come with some risks, and we've found 1 warning sign that you should be aware of.

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