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If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. That's why when we briefly looked at Arista Networks' (NYSE:ANET) ROCE trend, we were pretty happy with what we saw.
What is Return On Capital Employed (ROCE)?
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. Analysts use this formula to calculate it for Arista Networks:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = US$693m ÷ (US$4.4b - US$665m) (Based on the trailing twelve months to September 2020).
So, Arista Networks has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 7.3% generated by the Communications industry.
Above you can see how the current ROCE for Arista Networks compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
While the returns on capital are good, they haven't moved much. The company has consistently earned 19% for the last five years, and the capital employed within the business has risen 340% in that time. Since 19% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
The Bottom Line
The main thing to remember is that Arista Networks has proven its ability to continually reinvest at respectable rates of return. On top of that, the stock has rewarded shareholders with a remarkable 303% return to those who've held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
One more thing, we've spotted 2 warning signs facing Arista Networks that you might find interesting.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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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