If you're looking for a multi-bagger, there's a few things to keep an eye out 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, the ROCE of Cadence Design Systems (NASDAQ:CDNS) looks great, so lets see what the trend can tell us.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Cadence Design Systems, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = US$778m ÷ (US$4.4b - US$971m) (Based on the trailing twelve months to January 2022).
So, Cadence Design Systems has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Software industry average of 9.4%.
Above you can see how the current ROCE for Cadence Design Systems compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Cadence Design Systems here for free.
The Trend Of ROCE
We like the trends that we're seeing from Cadence Design Systems. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 23%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 126%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Bottom Line
To sum it up, Cadence Design Systems has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Since the stock has returned a staggering 409% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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.