Xero (ASX:XRO) Is Doing The Right Things To Multiply Its Share Price

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, Xero (ASX:XRO) looks quite promising in regards to its trends of return on capital.

What Is 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 Xero, this is the formula:

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

0.041 = NZ$92m ÷ (NZ$2.5b - NZ$255m) (Based on the trailing twelve months to March 2023).

So, Xero has an ROCE of 4.1%. Ultimately, that's a low return and it under-performs the Software industry average of 12%.

See our latest analysis for Xero

In the above chart we have measured Xero's 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 report on analyst forecasts for the company.

How Are Returns Trending?

We're delighted to see that Xero is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 4.1% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Xero is utilizing 693% more capital than it was five years ago. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

The Bottom Line On Xero's ROCE

To the delight of most shareholders, Xero has now broken into profitability. Since the stock has returned a staggering 162% to shareholders over the last five years, it looks like investors are recognizing these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation that compares the share price and estimated value.

While Xero 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.