If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. In light of that, when we looked at Cerence (NASDAQ:CRNC) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What Is It?
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. Analysts use this formula to calculate it for Cerence:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.037 = US$42m ÷ (US$1.3b - US$120m) (Based on the trailing twelve months to December 2023).
Therefore, Cerence has an ROCE of 3.7%. Ultimately, that's a low return and it under-performs the Software industry average of 7.2%.
In the above chart we have measured Cerence's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Cerence .
What Does the ROCE Trend For Cerence Tell Us?
Things have been pretty stable at Cerence, with its capital employed and returns on that capital staying somewhat the same for the last five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So unless we see a substantial change at Cerence in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger.
Our Take On Cerence's ROCE
We can conclude that in regards to Cerence's returns on capital employed and the trends, there isn't much change to report on. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 85% over the last three years. Therefore based on the analysis done in this article, we don't think Cerence has the makings of a multi-bagger.
One more thing to note, we've identified 2 warning signs with Cerence and understanding these should be part of your investment process.
While Cerence 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.