Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. So, when we ran our eye over Arista Networks’ (NYSE:ANET) trend of ROCE, we liked what we saw.
Understanding 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 Arista Networks, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.19 = US$693m ÷ (US$4.4b – US$665m) (Based on the trailing twelve months to September 2020).
Thus, Arista Networks has an ROCE of 19%. In absolute terms, that’s a satisfactory return, but compared to the Communications industry average of 8.7% it’s much better.
Check out our latest analysis for Arista Networks
In the above chart we have measured Arista Networks’ prior ROCE against its prior performance, but the future is arguably more important. If you’d like to see what analysts are forecasting going forward, you should check out our free report for Arista Networks.
What Can We Tell From Arista Networks’ ROCE Trend?
The trend of ROCE doesn’t stand out much, but returns on a whole are decent. The company has consistently earned 19% for the last five years, and the capital employed within the business has risen 340% in that time. 19% is a pretty standard return, and it provides some comfort knowing that Arista Networks has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
The main thing to remember is that Arista Networks has proven its ability to continually reinvest at respectable rates of return. On top of that, the stock has rewarded shareholders with a remarkable 268% return to those who’ve held over the last five years. So even though the stock might be more “expensive” than it was before, we think the strong fundamentals warrant this stock for further research.
One more thing to note, we’ve identified 2 warning signs with Arista Networks and understanding them should be part of your investment process.
While Arista Networks 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.
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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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