There are a few key trends to look for if we want to identify the next multi-bagger. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 on that note, Rapid7 (NASDAQ:RPD) looks quite promising in regards to its trends of return on capital.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Rapid7, this is the formula:

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

0.041 = US$39m ÷ (US$1.5b - US$579m) (Based on the trailing twelve months to June 2024).

Therefore, Rapid7 has an ROCE of 4.1%. Ultimately, that's a low return and it under-performs the Software industry average of 8.4%.

Above you can see how the current ROCE for Rapid7 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 Rapid7 for free.

So How Is Rapid7's ROCE Trending?

Rapid7 has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses five years ago, but now it's earning 4.1% which is a sight for sore eyes. In addition to that, Rapid7 is employing 146% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

In Conclusion...

Long story short, we're delighted to see that Rapid7's reinvestment activities have paid off and the company is now profitable. Astute investors may have an opportunity here because the stock has declined 18% in the last five years. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Rapid7 (of which 1 is a bit concerning!) that you should know about.

While Rapid7 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. 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.