We Like These Underlying Return On Capital Trends At Palo Alto Networks (NASDAQ:PANW)

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. So on that note, Palo Alto Networks (NASDAQ:PANW) looks quite promising in regards to its trends of return on capital.

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. To calculate this metric for Palo Alto Networks, this is the formula:

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

0.057 = US$387m ÷ (US$15b - US$7.7b) (Based on the trailing twelve months to July 2023).

Therefore, Palo Alto Networks has an ROCE of 5.7%. In absolute terms, that's a low return and it also under-performs the Software industry average of 8.9%.

See our latest analysis for Palo Alto Networks

Above you can see how the current ROCE for Palo Alto Networks 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 Palo Alto Networks.

What Can We Tell From Palo Alto Networks' ROCE Trend?

The fact that Palo Alto Networks is now generating some pre-tax profits from its prior investments is very encouraging. About five years ago the company was generating losses but things have turned around because it's now earning 5.7% on its capital. And unsurprisingly, like most companies trying to break into the black, Palo Alto Networks is utilizing 76% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 53% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

What We Can Learn From Palo Alto Networks' ROCE

To the delight of most shareholders, Palo Alto Networks has now broken into profitability. Since the stock has returned a staggering 322% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

One more thing to note, we've identified 2 warning signs with Palo Alto Networks and understanding these should be part of your investment process.

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. 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.