What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 when we looked at Vertex (NASDAQ:VERX) and its trend of ROCE, we really liked what we saw.
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 Vertex, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.016 = US$9.3m ÷ (US$1.0b - US$439m) (Based on the trailing twelve months to June 2024).
Thus, Vertex has an ROCE of 1.6%. In absolute terms, that's a low return and it also under-performs the Software industry average of 8.4%.
Above you can see how the current ROCE for Vertex compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Vertex for free.
What Can We Tell From Vertex's ROCE Trend?
We're delighted to see that Vertex is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses three years ago, but now it's earning 1.6% which is a sight for sore eyes. In addition to that, Vertex is employing 107% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 43%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So this improvement in ROCE has come from the business' underlying economics, which is great to see. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.
Our Take On Vertex's ROCE
In summary, it's great to see that Vertex has managed to break into profitability and is continuing to reinvest in its business. Since the stock has returned a solid 84% to shareholders over the last three years, it's fair to say investors are beginning to recognize these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
If you'd like to know about the risks facing Vertex, we've discovered 3 warning signs that you should be aware of.
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.