What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in Cerence's (NASDAQ:CRNC) returns on capital, so let's have a look.

Understanding Return On Capital Employed (ROCE)

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. Analysts use this formula to calculate it for Cerence:

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

0.095 = US$46m ÷ (US$702m - US$217m) (Based on the trailing twelve months to September 2024).

Thus, Cerence has an ROCE of 9.5%. In absolute terms, that's a low return but it's around the Software industry average of 8.3%.

Check out our latest analysis for Cerence

In the above chart we have measured Cerence's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Cerence .

What Can We Tell From Cerence's ROCE Trend?

We're pretty happy with how the ROCE has been trending at Cerence. The figures show that over the last five years, returns on capital have grown by 257%. 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 64% less than it was five years ago, which can be indicative of a business that's improving its efficiency. Cerence may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.

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 31% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line On Cerence's ROCE

From what we've seen above, Cerence has managed to increase it's returns on capital all the while reducing it's capital base. And since the stock has fallen 51% over the last five years, there might be an opportunity here. With that in mind, we believe the promising trends warrant this stock for further investigation.

Cerence does have some risks, we noticed 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should 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.