Returns Are Gaining Momentum At Darktrace (LON:DARK)

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'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Darktrace (LON:DARK) and its trend of ROCE, we really liked what we saw.

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. To calculate this metric for Darktrace, this is the formula:

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

0.037 = US$15m ÷ (US$729m - US$324m) (Based on the trailing twelve months to June 2022).

So, Darktrace has an ROCE of 3.7%. Ultimately, that's a low return and it under-performs the Software industry average of 7.9%.

Check out the opportunities and risks within the GB Software industry.

Above you can see how the current ROCE for Darktrace compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Darktrace.

What The Trend Of ROCE Can Tell Us

We're delighted to see that Darktrace is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making four years ago but is is now generating 3.7% on its capital. Not only that, but the company is utilizing 596% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

On a related note, the company's ratio of current liabilities to total assets has decreased to 44%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So this improvement in ROCE has come from the business' underlying economics, which is great to see. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.

Our Take On Darktrace's ROCE

Long story short, we're delighted to see that Darktrace's reinvestment activities have paid off and the company is now profitable. Given the stock has declined 61% in the last year, this could be a good investment if the valuation and other metrics are also appealing. With that in mind, we believe the promising trends warrant this stock for further investigation.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Darktrace (of which 1 shouldn't be ignored!) that you should know about.

While Darktrace 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.