There are a few key trends to look for if we want to identify the next multi-bagger. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Endava (NYSE:DAVA) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Endava:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = UK£48m ÷ (UK£390m - UK£81m) (Based on the trailing twelve months to December 2020).
Therefore, Endava has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 11% generated by the IT industry.
In the above chart we have measured Endava's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Endava.
What Can We Tell From Endava's ROCE Trend?
In terms of Endava's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 59%, but since then they've fallen to 15%. 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.
On a side note, Endava has done well to pay down its current liabilities to 21% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
Our Take On Endava'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 Endava. And long term investors must be optimistic going forward because the stock has returned a huge 120% to shareholders in the last year. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
One more thing, we've spotted 1 warning sign facing Endava 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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