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What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. 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 Gresham Technologies (LON:GHT) 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. The formula for this calculation on Gresham Technologies is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.013 = UK£700k ÷ (UK£80m - UK£25m) (Based on the trailing twelve months to June 2021).
Therefore, Gresham Technologies has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Software industry average of 9.0%.
Above you can see how the current ROCE for Gresham Technologies 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.
What Does the ROCE Trend For Gresham Technologies Tell Us?
On the surface, the trend of ROCE at Gresham Technologies doesn't inspire confidence. Around five years ago the returns on capital were 11%, but since then they've fallen to 1.3%. 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.
The Bottom Line On Gresham Technologies' ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Gresham Technologies is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 79% to shareholders over the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Gresham Technologies (of which 1 shouldn't be ignored!) that you should know about.
While Gresham Technologies isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.
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