Investors Will Want Cerence's (NASDAQ:CRNC) Growth In ROCE To Persist

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. So on that note, Cerence (NASDAQ:CRNC) looks quite promising in regards to its trends of return on capital.

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. Analysts use this formula to calculate it for Cerence:

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

0.12 = US$60m ÷ (US$674m - US$183m) (Based on the trailing twelve months to June 2024).

Therefore, Cerence has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 8.7% it's much better.

See our latest analysis for Cerence

In the above chart we have measured Cerence's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Cerence .

How Are Returns Trending?

Cerence has not disappointed in regards to ROCE growth. The figures show that over the last five years, returns on capital have grown by 304%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Speaking of capital employed, the company is actually utilizing 61% less than it was five years ago, which can be indicative of a business that's improving its efficiency. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 27% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line On Cerence's ROCE

In summary, it's great to see that Cerence has been able to turn things around and earn higher returns on lower amounts of capital. And since the stock has dived 79% over the last five years, there may be other factors affecting the company's prospects. Regardless, we think the underlying fundamentals warrant this stock for further investigation.

One final note, you should learn about the 3 warning signs we've spotted with Cerence (including 1 which can't be ignored) .

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.