To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 on that note, SolarWinds (NYSE:SWI) looks quite promising in regards to its trends of return on capital.

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 SolarWinds:

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

0.075 = US$194m ÷ (US$3.1b - US$455m) (Based on the trailing twelve months to June 2024).

Thus, SolarWinds has an ROCE of 7.5%. On its own, that's a low figure but it's around the 8.6% average generated by the Software industry.

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

How Are Returns Trending?

We're pretty happy with how the ROCE has been trending at SolarWinds. We found that the returns on capital employed over the last five years have risen by 163%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Speaking of capital employed, the company is actually utilizing 46% less than it was five years ago, which can be indicative of a business that's improving its efficiency. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.

The Bottom Line On SolarWinds' ROCE

In summary, it's great to see that SolarWinds has been able to turn things around and earn higher returns on lower amounts of capital. Given the stock has declined 24% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

If you want to know some of the risks facing SolarWinds we've found 3 warning signs (1 is significant!) that you should be aware of before investing here.

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.