essensys (LON:ESYS) 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. 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. However, after briefly looking over the numbers, we don't think essensys (LON:ESYS) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for essensys:

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

0.0052 = UK£90k ÷ (UK£23m - UK£5.5m) (Based on the trailing twelve months to July 2020).

So, essensys has an ROCE of 0.5%. In absolute terms, that's a low return and it also under-performs the Software industry average of 7.3%.

Check out our latest analysis for essensys

Above you can see how the current ROCE for essensys compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For essensys Tell Us?

Unfortunately, the trend isn't great with ROCE falling from 3.5% four years ago, while capital employed has grown 223%. Usually this isn't ideal, but given essensys conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence essensys might not have received a full period of earnings contribution from it.

On a related note, essensys has decreased its current liabilities to 24% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From essensys' ROCE

In summary, essensys is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 86% over the last year. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you'd like to know about the risks facing essensys, we've discovered 3 warning signs that you should be aware of.

While essensys isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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