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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. So, when we ran our eye over Amdocs' (NASDAQ:DOX) trend of ROCE, we liked what we saw.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Amdocs, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = US$591m ÷ (US$6.6b - US$1.3b) (Based on the trailing twelve months to June 2021).
Therefore, Amdocs has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 12% generated by the IT industry.
In the above chart we have measured Amdocs' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Amdocs here for free.
How Are Returns Trending?
While the returns on capital are good, they haven't moved much. The company has employed 35% more capital in the last five years, and the returns on that capital have remained stable at 11%. Since 11% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
What We Can Learn From Amdocs' ROCE
In the end, Amdocs has proven its ability to adequately reinvest capital at good rates of return. And the stock has followed suit returning a meaningful 42% to shareholders over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
If you want to know some of the risks facing Amdocs we've found 3 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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