What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we’ll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. And in light of that, the trends we’re seeing at Keystone Law Group’s (LON:KEYS) look very promising so lets take a look.
What is 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. The formula for this calculation on Keystone Law Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.28 = UK£4.8m ÷ (UK£30m – UK£13m) (Based on the trailing twelve months to July 2020).
Therefore, Keystone Law Group has an ROCE of 28%. In absolute terms that’s a great return and it’s even better than the Professional Services industry average of 13%.
Above you can see how the current ROCE for Keystone Law Group 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 free report for Keystone Law Group.
What Can We Tell From Keystone Law Group’s ROCE Trend?
We like the trends that we’re seeing from Keystone Law Group. Over the last five years, returns on capital employed have risen substantially to 28%. Basically the business is earning more per dollar of capital invested and in addition to that, 107% more capital is being employed now too. This can indicate that there’s plenty of opportunities to invest capital internally and at ever higher rates, a combination that’s common among multi-baggers.
On a separate but related note, it’s important to know that Keystone Law Group has a current liabilities to total assets ratio of 43%, which we’d consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we’d like to see this reduce as that would mean fewer obligations bearing risks.
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that’s what Keystone Law Group has. Since the stock has returned a staggering 157% to shareholders over the last three years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
One more thing to note, we’ve identified 2 warning signs with Keystone Law Group and understanding these should be part of your investment process.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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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