Investors Should Be Encouraged By Cadence Design Systems' (NASDAQ:CDNS) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. And in light of that, the trends we're seeing at Cadence Design Systems' (NASDAQ:CDNS) look very promising so lets take a look.

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. The formula for this calculation on Cadence Design Systems is:

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

0.28 = US$1.1b ÷ (US$5.2b - US$1.2b) (Based on the trailing twelve months to June 2023).

Thus, Cadence Design Systems has an ROCE of 28%. That's a fantastic return and not only that, it outpaces the average of 9.2% earned by companies in a similar industry.

Check out our latest analysis for Cadence Design Systems

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 to see what analysts are forecasting going forward, you should check out our free report for Cadence Design Systems.

How Are Returns Trending?

The trends we've noticed at Cadence Design Systems are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 28%. 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 139%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

One more thing to note, Cadence Design Systems has decreased current liabilities to 23% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So this improvement in ROCE has come from the business' underlying economics, which is great to see.

What We Can Learn From Cadence Design Systems' ROCE

All in all, it's terrific to see that Cadence Design Systems is reaping the rewards from prior investments and is growing its capital base. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.

If you want to continue researching Cadence Design Systems, you might be interested to know about the 1 warning sign that our analysis has discovered.

Cadence Design Systems is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.