Here's What Kainos Group's (LON:KNOS) Strong Returns On Capital Mean

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. That's why when we briefly looked at Kainos Group's (LON:KNOS) ROCE trend, we were very happy with what we saw.

Understanding 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 Kainos Group, this is the formula:

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

0.41 = UK£49m ÷ (UK£231m - UK£111m) (Based on the trailing twelve months to September 2022).

Therefore, Kainos Group has an ROCE of 41%. That's a fantastic return and not only that, it outpaces the average of 11% earned by companies in a similar industry.

See our latest analysis for Kainos Group

Above you can see how the current ROCE for Kainos Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Kainos Group here for free.

So How Is Kainos Group's ROCE Trending?

We'd be pretty happy with returns on capital like Kainos Group. The company has consistently earned 41% for the last five years, and the capital employed within the business has risen 229% in that time. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If Kainos Group can keep this up, we'd be very optimistic about its future.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 48% of total assets, this reported ROCE would probably be less than41% because total capital employed would be higher.The 41% ROCE could be even lower if current liabilities weren't 48% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.

What We Can Learn From Kainos Group's ROCE

In short, we'd argue Kainos Group has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. And the stock has done incredibly well with a 324% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.

Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation that compares the share price and estimated value.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.