If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in Teradata's (NYSE:TDC) returns on capital, so let's have a look.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Teradata, this is the formula:

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

0.15 = US$140m ÷ (US$1.9b - US$910m) (Based on the trailing twelve months to June 2023).

Thus, Teradata has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 8.9% it's much better.

View our latest analysis for Teradata

In the above chart we have measured Teradata's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Teradata here for free.

The Trend Of ROCE

We're pretty happy with how the ROCE has been trending at Teradata. The data shows that returns on capital have increased by 273% over the trailing five years. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Interestingly, the business may be becoming more efficient because it's applying 33% less capital than it was five years ago. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.

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 49% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.

The Bottom Line

In the end, Teradata has proven it's capital allocation skills are good with those higher returns from less amount of capital. Considering the stock has delivered 26% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. So with that in mind, we think the stock deserves further research.

Like most companies, Teradata does come with some risks, and we've found 1 warning sign that you should be aware of.

While Teradata isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.