What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Alfa Financial Software Holdings (LON:ALFA), we don't think it's current trends fit the mold of a multi-bagger.
Understanding 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. To calculate this metric for Alfa Financial Software Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = UK£19m ÷ (UK£133m - UK£25m) (Based on the trailing twelve months to June 2020).
Thus, Alfa Financial Software Holdings has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 9.1% generated by the Software industry.
In the above chart we have measured Alfa Financial Software Holdings' 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 Alfa Financial Software Holdings here for free.
So How Is Alfa Financial Software Holdings' ROCE Trending?
The trend of ROCE doesn't look fantastic because it's fallen from 38% five years ago, while the business's capital employed increased by 102%. That being said, Alfa Financial Software Holdings raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Alfa Financial Software Holdings 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. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.
The Bottom Line
To conclude, we've found that Alfa Financial Software Holdings is reinvesting in the business, but returns have been falling. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 71% over the last three years. Therefore based on the analysis done in this article, we don't think Alfa Financial Software Holdings has the makings of a multi-bagger.
One more thing: We've identified 2 warning signs with Alfa Financial Software Holdings (at least 1 which can't be ignored) , and understanding these would certainly be useful.
While Alfa Financial Software Holdings 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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