Cerence (NASDAQ:CRNC) Will Be Hoping To Turn Its Returns On Capital Around

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after briefly looking over the numbers, we don't think Cerence (NASDAQ:CRNC) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is 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 Cerence, this is the formula:

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

0.034 = US$53m ÷ (US$1.7b - US$161m) (Based on the trailing twelve months to March 2021).

Therefore, Cerence has an ROCE of 3.4%. In absolute terms, that's a low return and it also under-performs the Software industry average of 11%.

View 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'd like, you can check out the forecasts from the analysts covering Cerence here for free.

What The Trend Of ROCE Can Tell Us

In terms of Cerence's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 4.8% over the last three years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Our Take On Cerence's ROCE

To conclude, we've found that Cerence is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 230% return in the last year, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you want to continue researching Cerence, you might be interested to know about the 4 warning signs that our analysis has discovered.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. 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.
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