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Here's What's Concerning About Endava's (NYSE:DAVA) Returns On Capital

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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, while the ROCE is currently high for Endava (NYSE:DAVA), we aren't jumping out of our chairs because returns are decreasing.

What is 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. Analysts use this formula to calculate it for Endava:

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

0.20 = UK£84m ÷ (UK£539m - UK£119m) (Based on the trailing twelve months to December 2021).

Therefore, Endava has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.

View our latest analysis for Endava

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In the above chart we have measured Endava'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 Endava.

What Can We Tell From Endava's ROCE Trend?

On the surface, the trend of ROCE at Endava doesn't inspire confidence. Historically returns on capital were even higher at 52%, but they have dropped over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Endava has done well to pay down its current liabilities to 22% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Endava's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Endava. And the stock has done incredibly well with a 178% return over the last three years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One more thing, we've spotted 2 warning signs facing Endava that you might find interesting.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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.

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