Clearwater Analytics Holdings (NYSE:CWAN) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. However, after investigating Clearwater Analytics Holdings (NYSE:CWAN), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Clearwater Analytics Holdings is:

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

0.021 = US$8.7m ÷ (US$482m - US$66m) (Based on the trailing twelve months to December 2022).

Thus, Clearwater Analytics Holdings has an ROCE of 2.1%. In absolute terms, that's a low return and it also under-performs the Software industry average of 9.4%.

Check out our latest analysis for Clearwater Analytics Holdings

In the above chart we have measured Clearwater Analytics Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Clearwater Analytics Holdings' ROCE Trend?

On the surface, the trend of ROCE at Clearwater Analytics Holdings doesn't inspire confidence. To be more specific, ROCE has fallen from 59% over the last three years. 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.

On a related note, Clearwater Analytics Holdings has decreased its current liabilities to 14% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Clearwater Analytics Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Clearwater Analytics Holdings is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 16% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Clearwater Analytics Holdings could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.

While Clearwater Analytics Holdings 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.