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What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. 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 Ciena's (NYSE:CIEN) 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. To calculate this metric for Ciena, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$446m ÷ (US$4.7b - US$827m) (Based on the trailing twelve months to July 2021).
Therefore, Ciena has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 8.6% generated by the Communications industry.
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'd like, you can check out the forecasts from the analysts covering Ciena here for free.
How Are Returns Trending?
The trends we've noticed at Ciena are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 12%. Basically the business is earning more per dollar of capital invested and in addition to that, 97% more capital is being employed now too. So we're very much inspired by what we're seeing at Ciena thanks to its ability to profitably reinvest capital.
On a related note, the company's ratio of current liabilities to total assets has decreased to 18%, which basically reduces it's funding from the likes of short-term creditors or suppliers. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
Our Take On Ciena's ROCE
In summary, it's great to see that Ciena can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.
Ciena does have some risks though, and we've spotted 1 warning sign for Ciena that you might be interested in.
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.
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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