Ciena (NYSE:CIEN) Could Be Struggling To Allocate Capital

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Ciena (NYSE:CIEN) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Ciena, this is the formula:

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

0.078 = US$311m ÷ (US$4.9b - US$915m) (Based on the trailing twelve months to July 2022).

Therefore, Ciena has an ROCE of 7.8%. On its own, that's a low figure but it's around the 9.5% average generated by the Communications industry.

Our analysis indicates that CIEN is potentially undervalued!

Above you can see how the current ROCE for Ciena 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 report for Ciena.

The Trend Of ROCE

When we looked at the ROCE trend at Ciena, we didn't gain much confidence. To be more specific, ROCE has fallen from 11% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line

To conclude, we've found that Ciena is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 123% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Ciena does have some risks though, and we've spotted 1 warning sign for Ciena that you might be interested in.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.