Teradata (NYSE:TDC) Is Very Good At Capital Allocation

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. With that in mind, the ROCE of Teradata (NYSE:TDC) looks great, so lets see what the trend can tell us.

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 Teradata:

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

0.27 = US$212m ÷ (US$1.7b - US$875m) (Based on the trailing twelve months to September 2024).

So, Teradata has an ROCE of 27%. In absolute terms that's a great return and it's even better than the Software industry average of 9.0%.

See our latest analysis for Teradata

Above you can see how the current ROCE for Teradata compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Teradata .

The Trend Of ROCE

You'd find it hard not to be impressed with the ROCE trend at Teradata. We found that the returns on capital employed over the last five years have risen by 395%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. In regards to capital employed, Teradata appears to been achieving more with less, since the business is using 35% less capital to run its operation. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 53% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

What We Can Learn From Teradata's ROCE

In the end, Teradata has proven it's capital allocation skills are good with those higher returns from less amount of capital. Since the stock has only returned 26% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

One more thing to note, we've identified 2 warning signs with Teradata and understanding them should be part of your investment process.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.