SolarWinds (NYSE:SWI) Is Experiencing Growth In Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. So when we looked at SolarWinds (NYSE:SWI) and its trend of ROCE, we really liked what we saw.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for SolarWinds, this is the formula:

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

0.016 = US$58m ÷ (US$4.1b - US$412m) (Based on the trailing twelve months to June 2022).

So, SolarWinds has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the IT industry average of 12%.

See our latest analysis for SolarWinds

In the above chart we have measured SolarWinds' 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 report for SolarWinds.

What Can We Tell From SolarWinds' ROCE Trend?

It's great to see that SolarWinds has started to generate some pre-tax earnings from prior investments. The company was generating losses five years ago, but now it's turned around, earning 1.6% which is no doubt a relief for some early shareholders. At first glance, it seems the business is getting more proficient at generating returns, because over the same period, the amount of capital employed has reduced by 26%. SolarWinds could be selling under-performing assets since the ROCE is improving.

The Bottom Line On SolarWinds' ROCE

In summary, it's great to see that SolarWinds has been able to turn things around and earn higher returns on lower amounts of capital. Given the stock has declined 55% in the last three years, this could be a good investment if the valuation and other metrics are also appealing. With that in mind, we believe the promising trends warrant this stock for further investigation.

One more thing, we've spotted 1 warning sign facing SolarWinds that you might find interesting.

While SolarWinds may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.