If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Clearwater Analytics Holdings (NYSE:CWAN) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What Is It?
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 Clearwater Analytics Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.028 = US$10m ÷ (US$401m - US$30m) (Based on the trailing twelve months to June 2022).
Thus, Clearwater Analytics Holdings has an ROCE of 2.8%. In absolute terms, that's a low return and it also under-performs the Software industry average of 10%.
In the above chart we have measured Clearwater Analytics Holdings' 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 Clearwater Analytics Holdings.
So How Is Clearwater Analytics Holdings' ROCE Trending?
When we looked at the ROCE trend at Clearwater Analytics Holdings, we didn't gain much confidence. Around two years ago the returns on capital were 4.6%, but since then they've fallen to 2.8%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, Clearwater Analytics Holdings has done well to pay down its current liabilities to 7.4% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Key Takeaway
In summary, despite lower returns in the short term, we're encouraged to see that Clearwater Analytics Holdings is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 35% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
If you'd like to know about the risks facing Clearwater Analytics Holdings, we've discovered 1 warning sign that you should be aware of.
While Clearwater Analytics Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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