Investors Will Want Pure Storage's (NYSE:PSTG) Growth In ROCE To Persist

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. So on that note, Pure Storage (NYSE:PSTG) looks quite promising in regards to its trends of return on capital.

What Is Return On Capital Employed (ROCE)?

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 Pure Storage, this is the formula:

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

0.037 = US$78m ÷ (US$3.4b - US$1.2b) (Based on the trailing twelve months to November 2023).

Therefore, Pure Storage has an ROCE of 3.7%. In absolute terms, that's a low return and it also under-performs the Tech industry average of 7.1%.

Check out our latest analysis for Pure Storage

In the above chart we have measured Pure Storage'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 The Trend Of ROCE Can Tell Us

We're delighted to see that Pure Storage is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it's now earning 3.7% on its capital. In addition to that, Pure Storage is employing 53% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

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 37% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

What We Can Learn From Pure Storage's ROCE

To the delight of most shareholders, Pure Storage has now broken into profitability. And with a respectable 80% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

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

While Pure Storage 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.