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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. With that in mind, we've noticed some promising trends at Xunlei (NASDAQ:XNET) so let's look a bit deeper.
Return On Capital Employed (ROCE): What Is It?
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. Analysts use this formula to calculate it for Xunlei:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.029 = US$9.6m ÷ (US$441m - US$112m) (Based on the trailing twelve months to September 2022).
So, Xunlei has an ROCE of 2.9%. Ultimately, that's a low return and it under-performs the Software industry average of 10%.
Check out the opportunities and risks within the US Software industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Xunlei's past further, check out this free graph of past earnings, revenue and cash flow.
What Can We Tell From Xunlei's ROCE Trend?
We're delighted to see that Xunlei is reaping rewards from its investments and has now broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 2.9% on its capital. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.
Our Take On Xunlei's ROCE
As discussed above, Xunlei appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. However the stock is down a substantial 85% in the last five years so there could be other areas of the business hurting its prospects. Regardless, we think the underlying fundamentals warrant this stock for further investigation.
If you want to continue researching Xunlei, you might be interested to know about the 1 warning sign that our analysis has discovered.
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.
What are the risks and opportunities for Xunlei?
Price-To-Earnings ratio (7.1x) is below the US market (14.9x)
Earnings grew by 206.4% over the past year
Volatile share price over the past 3 months
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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.