If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after investigating Proact IT Group (STO:PACT), we don't think it's current trends fit the mold of a multi-bagger.
What is 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)
0.12 = kr185m ÷ (kr3.1b - kr1.5b) (Based on the trailing twelve months to March 2021).
So, Proact IT Group has an ROCE of 12%. In absolute terms, that's a pretty standard return but compared to the IT industry average it falls behind.
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 to see what analysts are forecasting going forward, you should check out our free report for Proact IT Group.
So How Is Proact IT Group's ROCE Trending?
When we looked at the ROCE trend at Proact IT Group, we didn't gain much confidence. Around five years ago the returns on capital were 27%, but since then they've fallen to 12%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, Proact IT Group has done well to pay down its current liabilities to 49% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
The Bottom Line On Proact IT Group's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Proact IT Group is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 157% to shareholders in the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
One more thing to note, we've identified 1 warning sign with Proact IT Group and understanding it should be part of your investment process.
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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