Here's What To Make Of Teradata's (NYSE:TDC) Decelerating Rates Of Return

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Teradata (NYSE:TDC), we don't think it's current trends fit the mold of a multi-bagger.

What is 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. To calculate this metric for Teradata, this is the formula:

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

0.18 = US$219m ÷ (US$2.2b - US$998m) (Based on the trailing twelve months to June 2021).

Therefore, Teradata has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 10.0% generated by the Software industry.

Check out our latest analysis for Teradata

In the above chart we have measured Teradata's 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 Does the ROCE Trend For Teradata Tell Us?

Over the past five years, Teradata's ROCE has remained relatively flat while the business is using 20% less capital than before. When a company effectively decreases its assets base, it's not usually a sign to be optimistic on that company. You could assume that if this continues, the business will be smaller in a few year time, so probably not a multi-bagger.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 44% of total assets, this reported ROCE would probably be less than18% because total capital employed would be higher.The 18% ROCE could be even lower if current liabilities weren't 44% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.

The Key Takeaway

It's a shame to see that Teradata is effectively shrinking in terms of its capital base. Since the stock has gained an impressive 65% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing, we've spotted 2 warning signs facing Teradata that you might find interesting.

While Teradata 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.
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