Will the Promising Trends At First Derivatives (LON:FDP) Continue?

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. So on that note, First Derivatives (LON:FDP) looks quite promising in regards to its trends of return on capital.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for First Derivatives, this is the formula:

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

0.076 = UK£23m ÷ (UK£369m - UK£63m) (Based on the trailing twelve months to August 2020).

Therefore, First Derivatives has an ROCE of 7.6%. In absolute terms, that's a low return but it's around the Software industry average of 7.4%.

Check out our latest analysis for First Derivatives

In the above chart we have measured First Derivatives' 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.

What Does the ROCE Trend For First Derivatives Tell Us?

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 7.6%. Basically the business is earning more per dollar of capital invested and in addition to that, 75% more capital is being employed now too. So we're very much inspired by what we're seeing at First Derivatives thanks to its ability to profitably reinvest capital.

In Conclusion...

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what First Derivatives has. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.

Like most companies, First Derivatives does come with some risks, and we've found 2 warning signs that you should be aware of.

While First Derivatives may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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This article by Simply Wall St is general in nature. 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.
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