What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Teradata (NYSE:TDC) and its trend of ROCE, we really liked what we saw.

Return On Capital Employed (ROCE): What Is It?

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 Teradata, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.19 = US$148m ÷ (US$1.7b - US$983m) (Based on the trailing twelve months to March 2024).

Therefore, Teradata has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 7.2% generated by the Software industry.

In the above chart we have measured Teradata's 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 Teradata for free.

How Are Returns Trending?

You'd find it hard not to be impressed with the ROCE trend at Teradata. The data shows that returns on capital have increased by 286% over the trailing five years. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Interestingly, the business may be becoming more efficient because it's applying 44% less capital than it was five years ago. Teradata may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.

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. Essentially the business now has suppliers or short-term creditors funding about 56% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

The Bottom Line On Teradata's ROCE

In the end, Teradata has proven it's capital allocation skills are good with those higher returns from less amount of capital. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. So researching this company further and determining whether or not these trends will continue seems justified.

One more thing to note, we've identified 2 warning signs with Teradata and understanding these should be part of your investment process.

While Teradata isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.