What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. 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)?
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. The formula for this calculation on Open Text is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.089 = US$733m ÷ (US$9.6b - US$1.3b) (Based on the trailing twelve months to March 2021).
So, Open Text has an ROCE of 8.9%. On its own, that's a low figure but it's around the 11% average generated by the Software industry.
In the above chart we have measured Open Text's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Open Text here for free.
What Does the ROCE Trend For Open Text Tell Us?
In terms of Open Text's historical ROCE trend, it doesn't exactly demand attention. The company has employed 115% more capital in the last five years, and the returns on that capital have remained stable at 8.9%. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
Our Take On Open Text's ROCE
In conclusion, Open Text has been investing more capital into the business, but returns on that capital haven't increased. Although the market must be expecting these trends to improve because the stock has gained 83% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
One more thing, we've spotted 4 warning signs facing Open Text that you might find interesting.
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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