There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Palo Alto Networks (NASDAQ:PANW) so let's look a bit deeper.

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. To calculate this metric for Palo Alto Networks, this is the formula:

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

0.081 = US$880m ÷ (US$18b - US$7.1b) (Based on the trailing twelve months to April 2024).

So, Palo Alto Networks has an ROCE of 8.1%. Even though it's in line with the industry average of 7.7%, it's still a low return by itself.

Above you can see how the current ROCE for Palo Alto Networks 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 Palo Alto Networks for free.

So How Is Palo Alto Networks' ROCE Trending?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. Over the last five years, returns on capital employed have risen substantially to 8.1%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 154%. So we're very much inspired by what we're seeing at Palo Alto Networks thanks to its ability to profitably reinvest capital.

In Conclusion...

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Palo Alto Networks has. Since the stock has returned a staggering 308% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

If you want to know some of the risks facing Palo Alto Networks we've found 3 warning signs (1 shouldn't be ignored!) that you should be aware of before investing here.

While Palo Alto Networks 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com