Should You Be Impressed By Open Text's (NASDAQ:OTEX) Returns on Capital?
If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. 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)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Open Text:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.072 = US$602m ÷ (US$10b - US$1.9b) (Based on the trailing twelve months to June 2020).
Therefore, Open Text has an ROCE of 7.2%. 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
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 to see what analysts are forecasting going forward, you should check out our free report for Open Text.
What The Trend Of ROCE Can Tell Us
In terms of Open Text's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 9.7% over the last five years. However it looks like Open Text might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
The Bottom Line
In summary, Open Text is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has gained an impressive 95% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
If you want to continue researching Open Text, you might be interested to know about the 3 warning signs that our analysis has discovered.
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.
This article by Simply Wall St is general in nature. 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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