Microlise Group (LON:SAAS) Is Reinvesting At Lower Rates Of Return

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Although, when we looked at Microlise Group (LON:SAAS), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Microlise Group, this is the formula:

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

0.023 = UK£2.2m ÷ (UK£121m - UK£26m) (Based on the trailing twelve months to December 2021).

So, Microlise Group has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the Software industry average of 7.4%.

See our latest analysis for Microlise Group

In the above chart we have measured Microlise Group'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 Microlise Group here for free.

What Can We Tell From Microlise Group's ROCE Trend?

On the surface, the trend of ROCE at Microlise Group doesn't inspire confidence. Around five years ago the returns on capital were 21%, but since then they've fallen to 2.3%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Microlise Group has decreased its current liabilities to 22% of total assets. So we could link some of this to the decrease in ROCE. 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 Microlise Group's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Microlise Group. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you want to continue researching Microlise Group, you might be interested to know about the 1 warning sign that our analysis has discovered.

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.