Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So on that note, Prologue (EPA:PROL) looks quite promising in regards to its trends of return on capital.
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 Prologue:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.067 = €3.6m ÷ (€94m - €40m) (Based on the trailing twelve months to June 2021).
So, Prologue has an ROCE of 6.7%. Ultimately, that's a low return and it under-performs the Software industry average of 9.8%.
In the above chart we have measured Prologue'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 Prologue.
How Are Returns Trending?
We're delighted to see that Prologue is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 6.7% on its capital. Not only that, but the company is utilizing 60% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
On a separate but related note, it's important to know that Prologue has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
Overall, Prologue gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And since the stock has fallen 64% over the last five years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
Prologue does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is significant...
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. 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.