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There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. With that in mind, we've noticed some promising trends at AppFolio (NASDAQ:APPF) so let's look a bit deeper.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on AppFolio is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.049 = US$13m ÷ (US$320m - US$47m) (Based on the trailing twelve months to June 2020).
Therefore, AppFolio has an ROCE of 4.9%. In absolute terms, that's a low return and it also under-performs the Software industry average of 9.3%.
In the above chart we have measured AppFolio's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for AppFolio.
What The Trend Of ROCE Can Tell Us
We're delighted to see that AppFolio is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it's now earning 4.9% on its capital. In addition to that, AppFolio is employing 241% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
Long story short, we're delighted to see that AppFolio's reinvestment activities have paid off and the company is now profitable. And a remarkable 823% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if AppFolio can keep these trends up, it could have a bright future ahead.
If you'd like to know about the risks facing AppFolio, we've discovered 2 warning signs that you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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