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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we’ve noticed some promising trends at Corero Network Security (LON:CNS) so let’s look a bit deeper.

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

For those who don’t know, ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Corero Network Security:

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

0.16 = US$2.7m (US$26m – US$8.8m) (Based on the trailing twelve months to June 2022).

So, Corero Network Security has an ROCE of 16%. On its own, that’s a standard return, however it’s much better than the 7.9% generated by the Software industry.

See our latest analysis for Corero Network Security

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Above you can see how the current ROCE for Corero Network Security 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 Corero Network Security here for free.

The Trend Of ROCE

We’re delighted to see that Corero Network Security is reaping rewards from its investments and has now broken into profitability. The company now earns 16% on its capital, because five years ago it was incurring losses. While returns have increased, the amount of capital employed by Corero Network Security has remained flat over the period. 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.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 34% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. It’s worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

What We Can Learn From Corero Network Security’s ROCE

As discussed above, Corero Network Security appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has returned a solid 65% to shareholders over the last five years, it’s fair to say investors are beginning to recognize these changes. In light of that, we think it’s worth looking further into this stock because if Corero Network Security can keep these trends up, it could have a bright future ahead.

On a final note, we found 2 warning signs for Corero Network Security (1 is a bit concerning) you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email the 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.

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