Some Investors May Be Worried About Open Text's (NASDAQ:OTEX) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Having said that, from a first glance at Open Text (NASDAQ:OTEX) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. To calculate this metric for Open Text, this is the formula:

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

0.047 = US$656m ÷ (US$17b - US$3.5b) (Based on the trailing twelve months to March 2023).

Thus, Open Text has an ROCE of 4.7%. Ultimately, that's a low return and it under-performs the Software industry average of 9.9%.

View 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

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 7.7%, but since then they've fallen to 4.7%. 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.

In Conclusion...

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 32% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

If you want to know some of the risks facing Open Text we've found 3 warning signs (1 is a bit concerning!) that you should be aware of before investing here.

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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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.