Pegasystems (NASDAQ:PEGA) Knows How To Allocate Capital Effectively

There are a few key trends to look for if we want to identify the next multi-bagger. 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. With that in mind, the ROCE of Pegasystems (NASDAQ:PEGA) looks great, so lets see what the trend can tell us.

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 Pegasystems is:

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

0.31 = US$172m ÷ (US$1.6b - US$1.0b) (Based on the trailing twelve months to September 2024).

Therefore, Pegasystems has an ROCE of 31%. In absolute terms that's a great return and it's even better than the Software industry average of 8.2%.

View our latest analysis for Pegasystems

In the above chart we have measured Pegasystems' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Pegasystems for free.

How Are Returns Trending?

We're delighted to see that Pegasystems is reaping rewards from its investments and has now broken into profitability. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 31%, which is always encouraging. While returns have increased, the amount of capital employed by Pegasystems has remained flat over the period. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.

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 65% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.

In Conclusion...

In summary, we're delighted to see that Pegasystems has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 7.6% to shareholders. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation for PEGA that compares the share price and estimated value.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.