Open Text (NASDAQ:OTEX) May Have Issues Allocating Its Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 investigating Open Text (NASDAQ:OTEX), we don't think it's current trends fit the mold of a multi-bagger.

What Is 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. The formula for this calculation on Open Text is:

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

0.049 = US$678m ÷ (US$17b - US$3.2b) (Based on the trailing twelve months to June 2023).

So, Open Text has an ROCE of 4.9%. Ultimately, that's a low return and it under-performs the Software industry average of 8.9%.

See our latest analysis for Open Text

Above you can see how the current ROCE for Open Text 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 Open Text.

So How Is Open Text's ROCE Trending?

In terms of Open Text's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 7.9%, but since then they've fallen to 4.9%. 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.

The Bottom Line On Open Text's 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 Open Text. In light of this, the stock has only gained 12% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

If you want to know some of the risks facing Open Text we've found 5 warning signs (1 is significant!) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.