Napatech's (OB:NAPA) Returns On Capital Are Heading Higher

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Napatech (OB:NAPA) so let's look a bit deeper.

What is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Napatech:

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

0.11 = kr.12m ÷ (kr.153m - kr.50m) (Based on the trailing twelve months to December 2020).

So, Napatech has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Communications industry average of 10%.

See our latest analysis for Napatech

Above you can see how the current ROCE for Napatech compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Napatech here for free.

The Trend Of ROCE

We're pretty happy with how the ROCE has been trending at Napatech. The figures show that over the last five years, returns on capital have grown by 332%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Interestingly, the business may be becoming more efficient because it's applying 50% less capital than it was five years ago. Napatech may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 33% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line

In the end, Napatech has proven it's capital allocation skills are good with those higher returns from less amount of capital. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 2.6% to shareholders. So with that in mind, we think the stock deserves further research.

On a separate note, we've found 2 warning signs for Napatech you'll probably want to know about.

While Napatech 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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This article by Simply Wall St is general in nature. 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.
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