What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. However, after investigating IDOX (LON:IDOX), we don't think it's current trends fit the mold of a multi-bagger.
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. The formula for this calculation on IDOX is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.052 = UK£5.1m ÷ (UK£145m - UK£49m) (Based on the trailing twelve months to April 2020).
Therefore, IDOX has an ROCE of 5.2%. In absolute terms, that's a low return and it also under-performs the Software industry average of 7.5%.
In the above chart we have measured IDOX's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering IDOX here for free.
So How Is IDOX's ROCE Trending?
Unfortunately, the trend isn't great with ROCE falling from 12% five years ago, while capital employed has grown 44%. Usually this isn't ideal, but given IDOX conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. IDOX probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by IDOX's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 8.8% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
IDOX does have some risks, we noticed 3 warning signs (and 2 which can't be ignored) we think you should know about.
While IDOX 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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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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