If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Altair Engineering (NASDAQ:ALTR), it didn't seem to tick all of these boxes.
What Is Return On Capital Employed (ROCE)?
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 Altair Engineering, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0057 = US$5.9m ÷ (US$1.4b - US$324m) (Based on the trailing twelve months to December 2023).
Thus, Altair Engineering has an ROCE of 0.6%. In absolute terms, that's a low return and it also under-performs the Software industry average of 7.4%.
Above you can see how the current ROCE for Altair Engineering 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 Altair Engineering for free.
What The Trend Of ROCE Can Tell Us
In terms of Altair Engineering's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 7.0% over the last five years. However it looks like Altair Engineering might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
Our Take On Altair Engineering's ROCE
Bringing it all together, while we're somewhat encouraged by Altair Engineering's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 124% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
On a final note, we've found 2 warning signs for Altair Engineering that we think you should be aware of.
While Altair Engineering 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.