If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Datadog (NASDAQ:DDOG) and its trend of ROCE, we really liked what we saw.

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. The formula for this calculation on Datadog is:

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

0.018 = US$48m ÷ (US$4.4b - US$1.8b) (Based on the trailing twelve months to June 2024).

Therefore, Datadog has an ROCE of 1.8%. Ultimately, that's a low return and it under-performs the Software industry average of 9.1%.

Above you can see how the current ROCE for Datadog 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 analyst report for Datadog .

What Does the ROCE Trend For Datadog Tell Us?

We're delighted to see that Datadog is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 1.8% which is a sight for sore eyes. Not only that, but the company is utilizing 2,395% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

One more thing to note, Datadog has decreased current liabilities to 41% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So this improvement in ROCE has come from the business' underlying economics, which is great to see. However, current liabilities are still at a pretty high level, so just be aware that this can bring with it some risks.

Our Take On Datadog's ROCE

Overall, Datadog 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 with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

On a separate note, we've found 2 warning signs for Datadog you'll probably want to know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.