Be Wary Of Cambridge Technology Enterprises (NSE:CTE) And Its Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Cambridge Technology Enterprises (NSE:CTE), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What is it?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Cambridge Technology Enterprises, this is the formula:

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

0.032 = ₹29m ÷ (₹1.1b - ₹243m) (Based on the trailing twelve months to September 2021).

Thus, Cambridge Technology Enterprises has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the IT industry average of 13%.

View our latest analysis for Cambridge Technology Enterprises

Historical performance is a great place to start when researching a stock so above you can see the gauge for Cambridge Technology Enterprises' ROCE against it's prior returns. If you'd like to look at how Cambridge Technology Enterprises has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Cambridge Technology Enterprises Tell Us?

When we looked at the ROCE trend at Cambridge Technology Enterprises, we didn't gain much confidence. Around five years ago the returns on capital were 28%, but since then they've fallen to 3.2%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Cambridge Technology Enterprises has decreased its current liabilities to 21% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

While returns have fallen for Cambridge Technology Enterprises in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat 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.

Cambridge Technology Enterprises does come with some risks though, we found 5 warning signs in our investment analysis, and 1 of those is a bit concerning...

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.