Capital Allocation Trends At Simulations Plus (NASDAQ:SLP) Aren't Ideal

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Simulations Plus (NASDAQ:SLP) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Simulations Plus is:

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

0.072 = US$13m ÷ (US$186m - US$12m) (Based on the trailing twelve months to August 2023).

Thus, Simulations Plus has an ROCE of 7.2%. On its own that's a low return, but compared to the average of 4.5% generated by the Healthcare Services industry, it's much better.

Check out our latest analysis for Simulations Plus

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, you can check out the forecasts from the analysts covering Simulations Plus here for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Simulations Plus doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.2% from 27% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that Simulations Plus is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 82% to shareholders over 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.

One more thing to note, we've identified 1 warning sign with Simulations Plus 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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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.