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. So when we looked at the ROCE trend of Pegasystems (NASDAQ:PEGA) we really liked what we saw.
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. To calculate this metric for Pegasystems, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.31 = US$172m ÷ (US$1.6b - US$1.0b) (Based on the trailing twelve months to September 2024).
Therefore, Pegasystems has an ROCE of 31%. That's a fantastic return and not only that, it outpaces the average of 8.9% earned by companies in a similar industry.
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.
What The Trend Of ROCE Can Tell Us
We're delighted to see that Pegasystems is reaping rewards from its investments and has now broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 31% on its capital. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. 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. Because in the end, a business can only get so efficient.
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 65% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
The Key Takeaway
In summary, we're delighted to see that Pegasystems has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 24% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
On a separate note, we've found 1 warning sign for Pegasystems you'll probably want to know about.
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.
