Proact IT Group's (STO:PACT) Returns On Capital Not Reflecting Well On The Business

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Having said that, from a first glance at Proact IT Group (STO:PACT) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Proact IT Group:

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

0.095 = kr181m ÷ (kr3.5b - kr1.6b) (Based on the trailing twelve months to March 2022).

Therefore, Proact IT Group has an ROCE of 9.5%. Ultimately, that's a low return and it under-performs the IT industry average of 26%.

Check out our latest analysis for Proact IT Group

In the above chart we have measured Proact IT Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Proact IT Group here for free.

What Does the ROCE Trend For Proact IT Group Tell Us?

On the surface, the trend of ROCE at Proact IT Group doesn't inspire confidence. Around five years ago the returns on capital were 25%, but since then they've fallen to 9.5%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Proact IT Group has done well to pay down its current liabilities to 46% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 46% is still pretty high, so those risks are still somewhat prevalent.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Proact IT Group's reinvestment in its own business, we're aware that returns are shrinking. And investors may be recognizing these trends since the stock has only returned a total of 21% to shareholders over the last five years. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing, we've spotted 1 warning sign facing Proact IT Group that you might find interesting.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.