To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Vertex's (NASDAQ:VERX) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Vertex:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.016 = US$4.7m ÷ (US$646m - US$346m) (Based on the trailing twelve months to September 2021).
Thus, Vertex has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the Software industry average of 11%.
In the above chart we have measured Vertex'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 Can We Tell From Vertex's ROCE Trend?
Vertex has broken into the black (profitability) and we're sure it's a sight for sore eyes. The company was generating losses one year ago, but has managed to turn it around and as we saw earlier is now earning 1.6%, which is always encouraging. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.
On a side note, Vertex's current liabilities are still rather high at 54% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Key Takeaway
As discussed above, Vertex appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And since the stock has fallen 48% over the last year, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.
If you want to continue researching Vertex, you might be interested to know about the 2 warning signs that our analysis has discovered.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.
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