If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. And in light of that, the trends we're seeing at Cisco Systems' (NASDAQ:CSCO) look very promising so lets take a look.
Return On Capital Employed (ROCE): What is it?
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 Cisco Systems:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = US$14b ÷ (US$93b - US$24b) (Based on the trailing twelve months to April 2022).
So, Cisco Systems has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Communications industry average of 9.0%.
In the above chart we have measured Cisco Systems' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Cisco Systems here for free.
What Can We Tell From Cisco Systems' ROCE Trend?
Cisco Systems has not disappointed in regards to ROCE growth. We found that the returns on capital employed over the last five years have risen by 65%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Interestingly, the business may be becoming more efficient because it's applying 33% less capital than it was five years ago. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.
What We Can Learn From Cisco Systems' ROCE
In a nutshell, we're pleased to see that Cisco Systems has been able to generate higher returns from less capital. Since the stock has returned a solid 64% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. In light of that, we think it's worth looking further into this stock because if Cisco Systems can keep these trends up, it could have a bright future ahead.
On a final note, we've found 1 warning sign for Cisco Systems that we think you should be aware of.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.