Converge Technology Solutions (TSE:CTS) Could Be Struggling To Allocate Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Converge Technology Solutions (TSE:CTS) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Converge Technology Solutions is:

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

0.049 = CA$48m ÷ (CA$2.2b - CA$1.2b) (Based on the trailing twelve months to March 2024).

Therefore, Converge Technology Solutions has an ROCE of 4.9%. In absolute terms, that's a low return and it also under-performs the IT industry average of 11%.

View our latest analysis for Converge Technology Solutions

roce

Above you can see how the current ROCE for Converge Technology Solutions 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 analyst report for Converge Technology Solutions .

So How Is Converge Technology Solutions' ROCE Trending?

In terms of Converge Technology Solutions' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 4.9% from 25% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Converge Technology Solutions has decreased its current liabilities to 54% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that Converge Technology Solutions is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 397% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One more thing, we've spotted 1 warning sign facing Converge Technology Solutions that you might find interesting.

While Converge Technology Solutions isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.

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