Is Converge Technology Solutions Struggling to Allocate Capital?

When searching for a stock that could multiply over the long term, there are certain 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. But what about Converge Technology Solutions (TSE:CTS)? Are they struggling to allocate capital?

Converge Technology Solutions is pursuing growth, but at what cost?

From a first glance, Converge Technology Solutions doesn’t exactly jump out at us as a company that’s allocating capital efficiently. But let’s have a deeper look. According to the company’s latest figures, the return on capital employed (ROCE) is a mere 4.9%. That’s a low return, and it also under-performs the IT industry average of 11%. But is this a cause for concern?

The ROCE formula sheds light on Converge Technology Solutions’ struggles.

The ROCE formula is simple: it’s the earnings before interest and tax (EBIT) divided by the total assets minus current liabilities. For Converge Technology Solutions, that works out to 0.049 = CA$48m ÷ (CA$2.2b - CA$1.2b). Not exactly a stellar performance.

So, How Is Converge Technology Solutions’ ROCE Trending?

Historically, Converge Technology Solutions’ ROCE movements haven’t been fantastic. Over the last five years, returns on capital have decreased from 25% to 4.9%. However, given that 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 could bode very well for long-term stock performance.

Converge Technology Solutions is betting on growth, but will it pay off?

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.

Converge Technology Solutions’ stock performance has been impressive, but can it continue?