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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in Red Violet's (NASDAQ:RDVT) returns on capital, so let's have a look.
Understanding 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. Analysts use this formula to calculate it for Red Violet:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.071 = US$6.7m ÷ (US$98m - US$4.6m) (Based on the trailing twelve months to September 2024).
Therefore, Red Violet has an ROCE of 7.1%. On its own, that's a low figure but it's around the 8.3% average generated by the Software industry.
Check out our latest analysis for Red Violet
Above you can see how the current ROCE for Red Violet 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 Red Violet for free.
The Trend Of ROCE
The fact that Red Violet is now generating some pre-tax profits from its prior investments is very encouraging. About five years ago the company was generating losses but things have turned around because it's now earning 7.1% on its capital. In addition to that, Red Violet is employing 109% more capital than previously which is expected of a company that's 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 Bottom Line On Red Violet's ROCE
To the delight of most shareholders, Red Violet has now broken into profitability. And with a respectable 68% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
Red Violet does have some risks though, and we've spotted 2 warning signs for Red Violet that you might be interested in.