Investors Could Be Concerned With SolarWinds' (NYSE:SWI) Returns On Capital

There are a few key trends to look for if we want to identify the next 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating SolarWinds (NYSE:SWI), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for SolarWinds:

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

0.022 = US$113m ÷ (US$5.7b - US$491m) (Based on the trailing twelve months to December 2020).

Thus, SolarWinds has an ROCE of 2.2%. In absolute terms, that's a low return and it also under-performs the Software industry average of 11%.

View our latest analysis for SolarWinds

Above you can see how the current ROCE for SolarWinds 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 SolarWinds here for free.

The Trend Of ROCE

On the surface, the trend of ROCE at SolarWinds doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.2% from 3.5% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

In Conclusion...

To conclude, we've found that SolarWinds is reinvesting in the business, but returns have been falling. And investors may be recognizing these trends since the stock has only returned a total of 4.1% to shareholders over the last year. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

On a separate note, we've found 2 warning signs for SolarWinds you'll probably want to know about.

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. 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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