If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. And in light of that, the trends we're seeing at Cadence Design Systems' (NASDAQ:CDNS) look very promising so lets take a look.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Cadence Design Systems, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.31 = US$1.3b ÷ (US$5.7b - US$1.6b) (Based on the trailing twelve months to December 2023).
Therefore, Cadence Design Systems has an ROCE of 31%. In absolute terms that's a great return and it's even better than the Software industry average of 7.7%.
In the above chart we have measured Cadence Design Systems' 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 Cadence Design Systems for free.
How Are Returns Trending?
Cadence Design Systems is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 31%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 131%. So we're very much inspired by what we're seeing at Cadence Design Systems thanks to its ability to profitably reinvest capital.
Our Take On Cadence Design Systems' ROCE
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Cadence Design Systems has. Since the stock has returned a staggering 401% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation for CDNS on our platform that is definitely worth checking out.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.