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What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Rapid7 (NASDAQ:RPD) so let's look a bit deeper.
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 Rapid7:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.045 = US$45m ÷ (US$1.6b - US$574m) (Based on the trailing twelve months to September 2024).
Therefore, Rapid7 has an ROCE of 4.5%. Ultimately, that's a low return and it under-performs the Software industry average of 8.9%.
See our latest analysis for Rapid7
In the above chart we have measured Rapid7'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 Rapid7 .
So How Is Rapid7's ROCE Trending?
The fact that Rapid7 is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 4.5% on its capital. Not only that, but the company is utilizing 164% more capital than before, but that's to be expected from a company trying to break into profitability. 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.
The Key Takeaway
Long story short, we're delighted to see that Rapid7's reinvestment activities have paid off and the company is now profitable. Astute investors may have an opportunity here because the stock has declined 30% in the last five years. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
If you want to know some of the risks facing Rapid7 we've found 4 warning signs (2 are significant!) that you should be aware of before investing here.
While Rapid7 isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.