If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Speaking of which, we noticed some great changes in Vertex's (NASDAQ:VERX) returns on capital, so let's have a look.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Vertex:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.03 = US$19m ÷ (US$1.2b - US$537m) (Based on the trailing twelve months to December 2024).

Therefore, Vertex has an ROCE of 3.0%. Ultimately, that's a low return and it under-performs the Software industry average of 9.2%.

In the above chart we have measured Vertex'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 Vertex for free.

What The Trend Of ROCE Can Tell Us

The fact that Vertex is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses four years ago, but now it's earning 3.0% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Vertex is utilizing 136% more capital than it was four years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

On a side note, Vertex's current liabilities are still rather high at 46% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

Overall, Vertex gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And a remarkable 124% total return over the last three years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

While Vertex looks impressive, no company is worth an infinite price. The intrinsic value infographic for VERX helps visualize whether it is currently trading for a fair price.

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.