Returns On Capital Signal Tricky Times Ahead For Gresham Technologies (LON:GHT)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. 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.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Gresham Technologies, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.046 = UK£2.7m ÷ (UK£80m - UK£21m) (Based on the trailing twelve months to June 2022).

Therefore, Gresham Technologies has an ROCE of 4.6%. Ultimately, that's a low return and it under-performs the Software industry average of 9.0%.

See our latest analysis for Gresham Technologies

roce

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.

So How Is Gresham Technologies' ROCE Trending?

In terms of Gresham Technologies' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 4.6% from 11% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

In Conclusion...

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. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Gresham Technologies does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is significant...

While Gresham Technologies 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.

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