Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. And in light of that, the trends we're seeing at Pegasystems' (NASDAQ:PEGA) look very promising so lets take a look.
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 Pegasystems, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.36 = US$188m ÷ (US$1.5b - US$1.0b) (Based on the trailing twelve months to June 2024).
Therefore, Pegasystems has an ROCE of 36%. In absolute terms that's a great return and it's even better than the Software industry average of 8.0%.
In the above chart we have measured Pegasystems' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Pegasystems for free.
The Trend Of ROCE
Shareholders will be relieved that Pegasystems has broken into profitability. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 36%, 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.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 66% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. And with current liabilities at those levels, that's pretty high.
What We Can Learn From Pegasystems' ROCE
To sum it up, Pegasystems is collecting higher returns from the same amount of capital, and that's impressive. Since the total return from the stock has been almost flat over the last five years, there might be an opportunity here if the valuation looks good. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
Like most companies, Pegasystems does come with some risks, and we've found 2 warning signs that you should be aware of.
Pegasystems is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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.
