ELEMENTS (TSE:5246) Is Looking To Continue Growing Its Returns On 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at ELEMENTS (TSE:5246) and its trend of ROCE, we really liked 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. Analysts use this formula to calculate it for ELEMENTS:

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

0.039 = JP¥171m ÷ (JP¥5.1b - JP¥743m) (Based on the trailing twelve months to August 2024).

Thus, ELEMENTS has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Software industry average of 16%.

Check out our latest analysis for ELEMENTS

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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of ELEMENTS.

How Are Returns Trending?

ELEMENTS has recently broken into profitability so their prior investments seem to be paying off. Shareholders would no doubt be pleased with this because the business was loss-making three years ago but is is now generating 3.9% on its capital. In addition to that, ELEMENTS is employing 124% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a related note, the company's ratio of current liabilities to total assets has decreased to 15%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

What We Can Learn From ELEMENTS' ROCE

Overall, ELEMENTS gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 29% return over the last year. Therefore, we think it would be worth your time to check if these trends are going to continue.

ELEMENTS does have some risks, we noticed 3 warning signs (and 1 which is significant) we think you should know about.

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.