If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Magic Software Enterprises is:

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

0.15 = US$57m ÷ (US$537m - US$162m) (Based on the trailing twelve months to March 2024).

Therefore, Magic Software Enterprises has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 8.6% it's much better.

Check out our latest analysis for Magic Software Enterprises

In the above chart we have measured Magic Software Enterprises' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Magic Software Enterprises .

What Can We Tell From Magic Software Enterprises' ROCE Trend?

Magic Software Enterprises has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 54% 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.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 30% of its operations, which isn't ideal. 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.

In Conclusion...

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. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 41% return over the last five years. In light of that, we think it's worth looking further into this stock because if Magic Software Enterprises can keep these trends up, it could have a bright future ahead.

One more thing, we've spotted 1 warning sign facing Magic Software Enterprises that you might find interesting.

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.