Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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.
What is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Cerence is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.034 = US$53m ÷ (US$1.7b - US$161m) (Based on the trailing twelve months to March 2021).
So, Cerence has an ROCE of 3.4%. In absolute terms, that's a low return and it also under-performs the Software industry average of 11%.
Above you can see how the current ROCE for Cerence compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Cerence.
What Does the ROCE Trend For Cerence Tell Us?
When we looked at the ROCE trend at Cerence, we didn't gain much confidence. To be more specific, ROCE has fallen from 4.8% over the last three years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
The Bottom Line On Cerence's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Cerence is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 246% return over the last year, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
On a final note, we've found 5 warning signs for Cerence that we think you should be aware of.
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.
This article by Simply Wall St is general in nature. 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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