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

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Although, when we looked at Simulations Plus (NASDAQ:SLP), it didn't seem to tick all of these boxes.

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. The formula for this calculation on Simulations Plus is:

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

0.073 = US$13m ÷ (US$186m - US$8.6m) (Based on the trailing twelve months to November 2023).

So, Simulations Plus has an ROCE of 7.3%. In absolute terms, that's a low return, but it's much better than the Healthcare Services industry average of 5.0%.

View 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 to see what analysts are forecasting going forward, you should check out our free report for Simulations Plus.

What Can We Tell From Simulations Plus' ROCE Trend?

On the surface, the trend of ROCE at Simulations Plus doesn't inspire confidence. Around five years ago the returns on capital were 27%, but since then they've fallen to 7.3%. 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. If these investments prove successful, this can bode very well for long term stock performance.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Simulations Plus. And long term investors must be optimistic going forward because the stock has returned a huge 111% 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.

If you'd like to know about the risks facing Simulations Plus, we've discovered 1 warning sign that you should be aware of.

While Simulations Plus may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.