There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it’s a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Paycom Software (NYSE:PAYC) 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 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 Paycom Software, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.19 = US$212m ÷ (US$3.2b – US$2.1b) (Based on the trailing twelve months to June 2021).
Thus, Paycom Software has an ROCE of 19%. On its own, that’s a standard return, however it’s much better than the 10% generated by the Software industry.
Above you can see how the current ROCE for Paycom Software 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.
The Trend Of ROCE
On the surface, the trend of ROCE at Paycom Software doesn’t inspire confidence. Around five years ago the returns on capital were 31%, but since then they’ve fallen to 19%. 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.
On a side note, Paycom Software has done well to pay down its current liabilities to 66% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it’s own money, you could argue this has made the business less efficient at generating ROCE. Either way, they’re still at a pretty high level, so we’d like to see them fall further if possible.
Our Take On Paycom Software’s ROCE
In summary, despite lower returns in the short term, we’re encouraged to see that Paycom Software is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 903% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we’d be optimistic on the stock going forward.
Paycom Software does have some risks though, and we’ve spotted 1 warning sign for Paycom Software that you might be interested in.
While Paycom Software isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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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