Origo hf (ICE:ORIGO) Could Be Struggling To Allocate Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Having said that, from a first glance at Origo hf (ICE:ORIGO) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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 Origo hf, this is the formula:

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

0.059 = Kr689m ÷ (Kr15b - Kr3.2b) (Based on the trailing twelve months to June 2022).

So, Origo hf has an ROCE of 5.9%. Ultimately, that's a low return and it under-performs the IT industry average of 13%.

View our latest analysis for Origo hf

Historical performance is a great place to start when researching a stock so above you can see the gauge for Origo hf's ROCE against it's prior returns. If you're interested in investigating Origo hf's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Origo hf Tell Us?

On the surface, the trend of ROCE at Origo hf doesn't inspire confidence. To be more specific, ROCE has fallen from 11% over the last five years. However it looks like Origo hf might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Origo hf has done well to pay down its current liabilities to 21% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

The Bottom Line On Origo hf's ROCE

To conclude, we've found that Origo hf is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 162% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

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

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.