Cerence (NASDAQ:CRNC) May Have Issues Allocating Its Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Cerence (NASDAQ:CRNC) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on Cerence is:

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

0.043 = US$66m ÷ (US$1.7b - US$165m) (Based on the trailing twelve months to September 2021).

Thus, Cerence has an ROCE of 4.3%. In absolute terms, that's a low return and it also under-performs the Software industry average of 11%.

Check out our latest analysis for Cerence

Above you can see how the current ROCE for Cerence 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 report on analyst forecasts for the company.

So How Is Cerence's ROCE Trending?

When we looked at the ROCE trend at Cerence, we didn't gain much confidence. Around four years ago the returns on capital were 5.3%, but since then they've fallen to 4.3%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Our Take On Cerence's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Cerence. And there could be an opportunity here if other metrics look good too, because the stock has declined 26% in the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a separate note, we've found 3 warning signs for Cerence you'll probably want to know about.

While Cerence 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.