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. 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. With that in mind, we've noticed some promising trends at Workday (NASDAQ:WDAY) so let's look a bit deeper.
Return On Capital Employed (ROCE): What Is It?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Workday is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.029 = US$342m ÷ (US$16b - US$4.5b) (Based on the trailing twelve months to July 2024).
Thus, Workday has an ROCE of 2.9%. 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 Workday 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 Workday for free.
The Trend Of ROCE
We're delighted to see that Workday is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 2.9% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Workday is utilizing 358% more capital than it was five years ago. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 28%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. This tells us that Workday has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.
The Bottom Line On Workday's ROCE
Long story short, we're delighted to see that Workday's reinvestment activities have paid off and the company is now profitable. Considering the stock has delivered 37% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. So with that in mind, we think the stock deserves further research.
Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation for WDAY that compares the share price and estimated value.
While Workday 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.