Ciena (NYSE:CIEN) May Have Issues Allocating Its Capital
If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Ciena (NYSE:CIEN), we don't think it's current trends fit the mold of a multi-bagger.
What Is 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. The formula for this calculation on Ciena is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.061 = US$286m ÷ (US$5.7b - US$1.0b) (Based on the trailing twelve months to January 2023).
Thus, Ciena has an ROCE of 6.1%. Ultimately, that's a low return and it under-performs the Communications industry average of 11%.
See our latest analysis for Ciena
Above you can see how the current ROCE for Ciena 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 Does the ROCE Trend For Ciena Tell Us?
When we looked at the ROCE trend at Ciena, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 6.1% from 8.9% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
What We Can Learn From Ciena's ROCE
Bringing it all together, while we're somewhat encouraged by Ciena's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 93% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
If you want to know some of the risks facing Ciena we've found 3 warning signs (1 makes us a bit uncomfortable!) that you should be aware of before investing here.
While Ciena may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.
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