CLPS Incorporation (NASDAQ:CLPS) Could Be Struggling To Allocate Capital

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. However, after briefly looking over the numbers, we don't think CLPS Incorporation (NASDAQ:CLPS) 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)

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. To calculate this metric for CLPS Incorporation, this is the formula:

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

0.016 = US$1.2m ÷ (US$112m - US$38m) (Based on the trailing twelve months to December 2022).

So, CLPS Incorporation has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the IT industry average of 14%.

View our latest analysis for CLPS Incorporation

Historical performance is a great place to start when researching a stock so above you can see the gauge for CLPS Incorporation's ROCE against it's prior returns. If you'd like to look at how CLPS Incorporation has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From CLPS Incorporation's ROCE Trend?

When we looked at the ROCE trend at CLPS Incorporation, we didn't gain much confidence. Around five years ago the returns on capital were 32%, but since then they've fallen to 1.6%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, CLPS Incorporation has done well to pay down its current liabilities to 34% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On CLPS Incorporation's ROCE

Bringing it all together, while we're somewhat encouraged by CLPS Incorporation's reinvestment in its own business, we're aware that returns are shrinking. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 92% over the last five years. Therefore based on the analysis done in this article, we don't think CLPS Incorporation has the makings of a multi-bagger.

If you'd like to know about the risks facing CLPS Incorporation, we've discovered 2 warning signs that you should be aware of.

While CLPS Incorporation isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.