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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in NetApp's (NASDAQ:NTAP) returns on capital, so let's have a look.
Understanding 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. To calculate this metric for NetApp, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$938m ÷ (US$9.4b - US$3.5b) (Based on the trailing twelve months to April 2021).
Thus, NetApp has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 8.3% generated by the Tech industry.
In the above chart we have measured NetApp's 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 NetApp here for free.
What Does the ROCE Trend For NetApp Tell Us?
NetApp's ROCE growth is quite impressive. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 144% over the last five years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
The Bottom Line On NetApp's ROCE
To sum it up, NetApp is collecting higher returns from the same amount of capital, and that's impressive. And a remarkable 241% 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 NetApp can keep these trends up, it could have a bright future ahead.
On a separate note, we've found 2 warning signs for NetApp you'll probably want to know about.
While NetApp isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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