If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Iress (ASX:IRE) and its ROCE trend, we weren't exactly thrilled.

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 Iress, this is the formula:

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

0.10 = AU$92m ÷ (AU$1.0b - AU$102m) (Based on the trailing twelve months to December 2020).

So, Iress has an ROCE of 10%.  In isolation, that's a pretty standard return but against the Software industry average of 14%, it's not as good.

Check out our latest analysis for Iress  roce

Above you can see how the current ROCE for Iress compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our freereport for Iress.

The Trend Of ROCE

The trend of ROCE doesn't look fantastic because it's fallen from 14% five years ago, while the business's capital employed increased by 56%. Usually this isn't ideal, but given Iress conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Iress' earnings and if they change as a result from the capital raise. It's also worth noting the company's latest EBIT figure is within 10% of the previous year, so it's fair to assign the ROCE drop largely to the capital raise.



The Key Takeaway

To conclude, we've found that Iress is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 58% over the last five years. 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'd like to know more about Iress, we've spotted  2 warning signs, and 1 of them is significant.

For those who like to invest in solid companies, check out this freelist of companies with solid balance sheets and high returns on equity.

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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