Here's What's Concerning About NEXTDC's (ASX:NXT) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. However, after investigating NEXTDC (ASX:NXT), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for NEXTDC:

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

0.0056 = AU$29m ÷ (AU$5.2b - AU$151m) (Based on the trailing twelve months to June 2024).

Thus, NEXTDC has an ROCE of 0.6%. Ultimately, that's a low return and it under-performs the IT industry average of 7.9%.

Check out our latest analysis for NEXTDC

Above you can see how the current ROCE for NEXTDC compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for NEXTDC .

How Are Returns Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 1.8% five years ago, while the business's capital employed increased by 188%. That being said, NEXTDC raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with NEXTDC's earnings and if they change as a result from the capital raise.

The Bottom Line On NEXTDC's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that NEXTDC is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 192% to shareholders in the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

NEXTDC does have some risks though, and we've spotted 2 warning signs for NEXTDC that you might be interested in.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.