If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at KL-Net (KOSDAQ:039420) 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?
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. The formula for this calculation on KL-Net is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.092 = ₩3.8b ÷ (₩47b - ₩6.0b) (Based on the trailing twelve months to September 2020).
Therefore, KL-Net has an ROCE of 9.2%. In absolute terms, that's a low return, but it's much better than the Software industry average of 7.2%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for KL-Net's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of KL-Net, check out these free graphs here.
What Can We Tell From KL-Net's ROCE Trend?
Things have been pretty stable at KL-Net, with its capital employed and returns on that capital staying somewhat the same for the last five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect KL-Net to be a multi-bagger going forward.
The Bottom Line On KL-Net's ROCE
We can conclude that in regards to KL-Net's returns on capital employed and the trends, there isn't much change to report on. Although the market must be expecting these trends to improve because the stock has gained 56% 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.
KL-Net does have some risks though, and we've spotted 1 warning sign for KL-Net that you might be interested in.
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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