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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So on that note, Magic Software Enterprises (NASDAQ:MGIC) looks quite promising in regards to its trends of return on capital.

Understanding 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. To calculate this metric for Magic Software Enterprises, this is the formula:

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

0.16 = US$58m ÷ (US$502m - US$137m) (Based on the trailing twelve months to September 2023).

Therefore, Magic Software Enterprises has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 7.7% generated by the Software industry.

See our latest analysis for Magic Software Enterprises

Above you can see how the current ROCE for Magic Software Enterprises compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Magic Software Enterprises here for free.

So How Is Magic Software Enterprises' ROCE Trending?

Magic Software Enterprises' ROCE growth is quite impressive. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 69% in that same time. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 27% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line On Magic Software Enterprises' ROCE

In summary, we're delighted to see that Magic Software Enterprises has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Since the stock has returned a solid 53% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

Magic Software Enterprises does have some risks, we noticed 2 warning signs (and 1 which is potentially serious) we think you should know about.

While Magic Software Enterprises may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.