Under The Bonnet, Linedata Services' (EPA:LIN) Returns Look Impressive

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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Speaking of which, we noticed some great changes in Linedata Services' (EPA:LIN) returns on capital, so let's have a look.

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. Analysts use this formula to calculate it for Linedata Services:

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

0.25 = €39m ÷ (€329m - €175m) (Based on the trailing twelve months to June 2022).

Thus, Linedata Services has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 11% earned by companies in a similar industry.

Our analysis indicates that LIN is potentially undervalued!

Above you can see how the current ROCE for Linedata Services 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 Linedata Services here for free.

What The Trend Of ROCE Can Tell Us

We're pretty happy with how the ROCE has been trending at Linedata Services. The data shows that returns on capital have increased by 60% over the trailing five years. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. In regards to capital employed, Linedata Services appears to been achieving more with less, since the business is using 26% less capital to run its operation. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 53% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

The Bottom Line On Linedata Services' ROCE

In summary, it's great to see that Linedata Services has been able to turn things around and earn higher returns on lower amounts of capital. Considering the stock has delivered 38% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

Linedata Services does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...

Linedata Services is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.