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Investors Met With Slowing Returns on Capital At Open Text (NASDAQ:OTEX)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Open Text (NASDAQ:OTEX), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

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. 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)

0.068 = US$660m ÷ (US$11b - US$1.5b) (Based on the trailing twelve months to December 2022).

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Thus, Open Text has an ROCE of 6.8%. Ultimately, that's a low return and it under-performs the Software industry average of 9.4%.

Check out our latest analysis for Open Text

roce
roce

In the above chart we have measured Open Text's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Open Text here for free.

So How Is Open Text's ROCE Trending?

There are better returns on capital out there than what we're seeing at Open Text. The company has employed 51% more capital in the last five years, and the returns on that capital have remained stable at 6.8%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

What We Can Learn From Open Text's ROCE

In conclusion, Open Text has been investing more capital into the business, but returns on that capital haven't increased. And investors may be recognizing these trends since the stock has only returned a total of 14% to shareholders over the last five years. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing: We've identified 3 warning signs with Open Text (at least 1 which shouldn't be ignored) , and understanding them would certainly be useful.

While Open Text isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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