Itesoft (EPA:ITE) Is Reinvesting At Lower Rates Of Return

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Itesoft (EPA:ITE) and its ROCE trend, we weren't exactly thrilled.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Itesoft, this is the formula:

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

0.055 = €1.0m ÷ (€33m - €15m) (Based on the trailing twelve months to June 2020).

So, Itesoft has an ROCE of 5.5%. In absolute terms, that's a low return and it also under-performs the Software industry average of 9.1%.

View our latest analysis for Itesoft

In the above chart we have measured Itesoft's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

In terms of Itesoft's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 11% over the last five years. However it looks like Itesoft might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Another thing to note, Itesoft has a high ratio of current liabilities to total assets of 44%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Itesoft's ROCE

In summary, Itesoft is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And with the stock having returned a mere 22% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

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

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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