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To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. So when we looked at Check Point Software Technologies (NASDAQ:CHKP), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
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. The formula for this calculation on Check Point Software Technologies is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.22 = US$918m ÷ (US$5.7b - US$1.5b) (Based on the trailing twelve months to March 2021).
Therefore, Check Point Software Technologies has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Software industry average of 11%.
In the above chart we have measured Check Point Software Technologies' prior ROCE against its prior performance, but the future is arguably more important. 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
There hasn't been much to report for Check Point Software Technologies' returns and its level of capital employed because both metrics have been steady for the past five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So it may not be a multi-bagger in the making, but given the decent 22% return on capital, it'd be difficult to find fault with the business's current operations.
What We Can Learn From Check Point Software Technologies' ROCE
Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. Although the market must be expecting these trends to improve because the stock has gained 49% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
If you're still interested in Check Point Software Technologies it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.
Check Point Software Technologies is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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