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What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. With that in mind, we've noticed some promising trends at Frontier Developments (LON:FDEV) so let's look a bit deeper.
What Is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Frontier Developments:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.081 = UK£8.4m ÷ (UK£120m - UK£17m) (Based on the trailing twelve months to November 2024).
Thus, Frontier Developments has an ROCE of 8.1%. In absolute terms, that's a low return and it also under-performs the Entertainment industry average of 12%.
See our latest analysis for Frontier Developments
In the above chart we have measured Frontier Developments' 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 Frontier Developments for free.
What Does the ROCE Trend For Frontier Developments Tell Us?
Frontier Developments has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 26% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
Our Take On Frontier Developments' ROCE
To sum it up, Frontier Developments is collecting higher returns from the same amount of capital, and that's impressive. Although the company may be facing some issues elsewhere since the stock has plunged 83% in the last five years. Regardless, we think the underlying fundamentals warrant this stock for further investigation.
On a final note, we found 2 warning signs for Frontier Developments (1 shouldn't be ignored) you should be aware of.