Magic Software Enterprises (NASDAQ:MGIC) Has More To Do To Multiply In Value Going Forward

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So, when we ran our eye over Magic Software Enterprises' (NASDAQ:MGIC) trend of ROCE, we liked what we saw.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Magic Software Enterprises:

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

0.12 = US$42m ÷ (US$443m - US$85m) (Based on the trailing twelve months to December 2020).

So, Magic Software Enterprises has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 11% generated by the Software industry.

View our latest analysis for Magic Software Enterprises

In the above chart we have measured Magic Software Enterprises' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

While the returns on capital are good, they haven't moved much. The company has consistently earned 12% for the last five years, and the capital employed within the business has risen 69% in that time. 12% is a pretty standard return, and it provides some comfort knowing that Magic Software Enterprises has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

The Bottom Line

To sum it up, Magic Software Enterprises has simply been reinvesting capital steadily, at those decent rates of return. And long term investors would be thrilled with the 174% return they've received over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

On a separate note, we've found 1 warning sign for Magic Software Enterprises you'll probably want to know about.

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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