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

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Simulations Plus (NASDAQ:SLP) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. To calculate this metric for Simulations Plus, this is the formula:

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

0.047 = US$8.7m ÷ (US$197m - US$12m) (Based on the trailing twelve months to August 2024).

Therefore, Simulations Plus has an ROCE of 4.7%. In absolute terms, that's a low return and it also under-performs the Healthcare Services industry average of 6.8%.

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

What The Trend Of ROCE Can Tell Us

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 4.7% from 26% five years ago. 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.

In Conclusion...

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. However, total returns to shareholders over the last five years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

While Simulations Plus doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation for SLP on our platform.

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.