If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. So when we looked at Pure Storage (NYSE:PSTG) and its trend of ROCE, we really liked what we saw.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Pure Storage:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.014 = US$21m ÷ (US$3.0b - US$1.5b) (Based on the trailing twelve months to August 2022).
Thus, Pure Storage has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Tech industry average of 11%.
See our latest analysis for Pure Storage
Above you can see how the current ROCE for Pure Storage compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Pure Storage's ROCE Trending?
We're delighted to see that Pure Storage is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 1.4% on its capital. Not only that, but the company is utilizing 150% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 50% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.
What We Can Learn From Pure Storage's ROCE
Overall, Pure Storage 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 investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 76% return over the last five years. In light of that, we think it's worth looking further into this stock because if Pure Storage can keep these trends up, it could have a bright future ahead.
One more thing, we've spotted 2 warning signs facing Pure Storage that you might find interesting.
While Pure Storage 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.
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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October 02, 2022 at 11:52AM
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Pure Storage (NYSE:PSTG) Is Experiencing Growth In Returns On Capital - Simply Wall St
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