Some Investors May Be Worried About Simulations Plus' (NASDAQ:SLP) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Simulations Plus (NASDAQ:SLP) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

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. 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)

0.066 = US$12m ÷ (US$190m - US$8.0m) (Based on the trailing twelve months to November 2022).

Thus, Simulations Plus has an ROCE of 6.6%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.6%.

Check out 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.

The Trend Of ROCE

In terms of Simulations Plus' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 6.6% from 28% 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Simulations Plus has done well to pay down its current liabilities to 4.2% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Simulations Plus' ROCE

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 the stock has done incredibly well with a 152% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

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.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.