What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Speaking of which, we noticed some great changes in CreoLtd's (TYO:9698) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on CreoLtd is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = JP¥919m ÷ (JP¥8.5b - JP¥2.0b) (Based on the trailing twelve months to December 2020).
Therefore, CreoLtd has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 15% generated by the Software industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how CreoLtd has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From CreoLtd's ROCE Trend?
We like the trends that we're seeing from CreoLtd. The data shows that returns on capital have increased substantially over the last five years to 14%. Basically the business is earning more per dollar of capital invested and in addition to that, 25% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Bottom Line
In summary, it's great to see that CreoLtd can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if CreoLtd can keep these trends up, it could have a bright future ahead.
While CreoLtd looks impressive, no company is worth an infinite price. The intrinsic value infographic in our free research report helps visualize whether 9698 is currently trading for a fair price.
While CreoLtd 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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