What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. In light of that, when we looked at NextGen Healthcare (NASDAQ:NXGN) and its ROCE trend, we weren't exactly thrilled.
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. To calculate this metric for NextGen Healthcare, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.038 = US$19m ÷ (US$656m - US$160m) (Based on the trailing twelve months to December 2020).
Therefore, NextGen Healthcare has an ROCE of 3.8%. Ultimately, that's a low return and it under-performs the Healthcare Services industry average of 6.8%.
In the above chart we have measured NextGen Healthcare'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 NextGen Healthcare here for free.
What Does the ROCE Trend For NextGen Healthcare Tell Us?
On the surface, the trend of ROCE at NextGen Healthcare doesn't inspire confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 3.8%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
The Bottom Line On NextGen Healthcare's ROCE
In summary, NextGen Healthcare is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has gained an impressive 45% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Like most companies, NextGen Healthcare does come with some risks, and we've found 2 warning signs that you should be aware of.
While NextGen Healthcare 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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