Here's What's Concerning About Simulations Plus' (NASDAQ:SLP) Returns On Capital

What are the early trends we should look for to identify a stock that could 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. 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.

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. Analysts use this formula to calculate it for Simulations Plus:

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

0.08 = US$14m ÷ (US$186m - US$5.9m) (Based on the trailing twelve months to May 2022).

Thus, Simulations Plus has an ROCE of 8.0%. Even though it's in line with the industry average of 7.6%, it's still a low return by itself.

See our latest analysis for Simulations Plus

Above you can see how the current ROCE for Simulations Plus compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Simulations Plus.

So How Is Simulations Plus' ROCE Trending?

When we looked at the ROCE trend at Simulations Plus, we didn't gain much confidence. Around five years ago the returns on capital were 28%, but since then they've fallen to 8.0%. 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. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line On Simulations Plus' ROCE

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 done incredibly well with a 267% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you're still interested in Simulations Plus it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

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.