Some Investors May Be Worried About Crimson Tide's (LON:TIDE) Returns On Capital

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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Crimson Tide (LON:TIDE) and its ROCE trend, we weren't exactly thrilled.

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 Crimson Tide:

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

0.045 = UK£455k ÷ (UK£11m - UK£882k) (Based on the trailing twelve months to June 2021).

Therefore, Crimson Tide has an ROCE of 4.5%. Ultimately, that's a low return and it under-performs the Software industry average of 8.3%.

View our latest analysis for Crimson Tide

In the above chart we have measured Crimson Tide'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 Crimson Tide.

So How Is Crimson Tide's ROCE Trending?

When we looked at the ROCE trend at Crimson Tide, we didn't gain much confidence. Around five years ago the returns on capital were 11%, but since then they've fallen to 4.5%. 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 side note, Crimson Tide has done well to pay down its current liabilities to 8.1% 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 Crimson Tide's ROCE

While returns have fallen for Crimson Tide in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 24% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Crimson Tide (of which 2 make us uncomfortable!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.