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If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at Palo Alto Networks (NASDAQ:PANW) so let's look a bit deeper.
Understanding 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 Palo Alto Networks, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.057 = US$387m ÷ (US$15b - US$7.7b) (Based on the trailing twelve months to July 2023).
Therefore, Palo Alto Networks has an ROCE of 5.7%. Ultimately, that's a low return and it under-performs the Software industry average of 8.9%.
Check out our latest analysis for Palo Alto Networks
In the above chart we have measured Palo Alto Networks' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Palo Alto Networks here for free.
What Does the ROCE Trend For Palo Alto Networks Tell Us?
The fact that Palo Alto Networks is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 5.7% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Palo Alto Networks is utilizing 76% more capital than it was five years ago. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 53% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.
The Key Takeaway
Overall, Palo Alto Networks gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Palo Alto Networks can keep these trends up, it could have a bright future ahead.