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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. So when we looked at the ROCE trend of Cadence Design Systems (NASDAQ:CDNS) we really liked what we saw.
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)
0.22 = US$720m ÷ (US$4.0b - US$792m) (Based on the trailing twelve months to April 2021).
Thus, Cadence Design Systems has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 11% earned by companies in a similar industry.
View our latest analysis for Cadence Design Systems
Above you can see how the current ROCE for Cadence Design Systems 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 Cadence Design Systems here for free.
What The Trend Of ROCE Can Tell Us
Investors would be pleased with what's happening at Cadence Design Systems. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 22%. Basically the business is earning more per dollar of capital invested and in addition to that, 63% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
The Key Takeaway
In summary, it's great to see that Cadence Design Systems can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And a remarkable 393% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.