What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So on that note, SolarWinds (NYSE:SWI) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What Is It?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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)
0.033 = US$102m ÷ (US$3.5b - US$433m) (Based on the trailing twelve months to September 2022).
Thus, SolarWinds has an ROCE of 3.3%. In absolute terms, that's a low return and it also under-performs the Software industry average of 10%.
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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is SolarWinds' ROCE Trending?
It's great to see that SolarWinds has started to generate some pre-tax earnings from prior investments. While the business is profitable now, it used to be incurring losses on invested capital five years ago. 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 39%. This could potentially mean that the company is selling some of its assets.
The Key Takeaway
In the end, SolarWinds has proven it's capital allocation skills are good with those higher returns from less amount of capital. Given the stock has declined 50% in the last three years, this could be a good investment if the valuation and other metrics are also appealing. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
On a final note, we've found 1 warning sign for SolarWinds that we think you should be aware of.
While SolarWinds 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.
About NYSE:SWI
SolarWinds
Provides information technology (IT) management software products in the United States and internationally.
Moderate growth potential with acceptable track record.
