Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Simulations Plus (NASDAQ:SLP) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What is it?
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. The formula for this calculation on Simulations Plus is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = US$12m ÷ (US$181m - US$9.6m) (Based on the trailing twelve months to November 2021).
Thus, Simulations Plus has an ROCE of 7.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.0%.
In the above chart we have measured Simulations Plus' 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 Simulations Plus.
What Does the ROCE Trend For Simulations Plus Tell Us?
On the surface, the trend of ROCE at Simulations Plus doesn't inspire confidence. Around five years ago the returns on capital were 28%, but since then they've fallen to 7.0%. 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.
While returns have fallen for Simulations Plus in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 405% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
Simulations Plus could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
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.
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.