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COSOL (ASX:COS) Is Experiencing Growth In Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. So on that note, COSOL (ASX:COS) looks quite promising in regards to its trends of return on capital.

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 COSOL, this is the formula:

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

0.19 = AU$5.5m ÷ (AU$38m - AU$9.8m) (Based on the trailing twelve months to June 2021).

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Thus, COSOL has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 11% it's much better.

Check out our latest analysis for COSOL

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roce

Historical performance is a great place to start when researching a stock so above you can see the gauge for COSOL's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of COSOL, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

The fact that COSOL is now generating some pre-tax profits from its prior investments is very encouraging. About four years ago the company was generating losses but things have turned around because it's now earning 19% on its capital. In addition to that, COSOL is employing 7,708% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

One more thing to note, COSOL has decreased current liabilities to 26% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

In Conclusion...

Overall, COSOL gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Investors may not be impressed by the favorable underlying trends yet because over the last year the stock has only returned 4.6% to shareholders. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

On a final note, we've found 3 warning signs for COSOL that we think you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.