What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we’ll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company’s amount 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. So when we looked at Redcentric (LON:RCN) and its trend of ROCE, we really liked what we saw.
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 Redcentric:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.094 = UK£8.7m ÷ (UK£122m – UK£30m) (Based on the trailing twelve months to September 2021).
Thus, Redcentric has an ROCE of 9.4%. On its own, that’s a low figure but it’s around the 12% average generated by the IT industry.
Above you can see how the current ROCE for Redcentric compares to its prior returns on capital, but there’s only so much you can tell from the past. If you’d like, you can check out the forecasts from the analysts covering Redcentric here for free.
What Does the ROCE Trend For Redcentric Tell Us?
Redcentric has broken into the black (profitability) and we’re sure it’s a sight for sore eyes. While the business was unprofitable in the past, it’s now turned things around and is earning 9.4% on its capital. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. With no noticeable increase in capital employed, it’s worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. Because in the end, a business can only get so efficient.
The Bottom Line
In summary, we’re delighted to see that Redcentric has been able to increase efficiencies and earn higher rates of return on the same amount of capital. And with a respectable 43% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. In light of that, we think it’s worth looking further into this stock because if Redcentric can keep these trends up, it could have a bright future ahead.
If you want to know some of the risks facing Redcentric we’ve found 3 warning signs (1 is a bit unpleasant!) that you should be aware of before investing here.
While Redcentric may not currently earn the highest returns, we’ve compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.