If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at NEXTDC (ASX:NXT) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on NEXTDC is:

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

0.0028 = AU$14m ÷ (AU$5.2b - AU$139m) (Based on the trailing twelve months to December 2024).

Therefore, NEXTDC has an ROCE of 0.3%. In absolute terms, that's a low return and it also under-performs the IT industry average of 7.6%.

View our latest analysis for NEXTDC

In the above chart we have measured NEXTDC'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 NEXTDC for free.

What Can We Tell From NEXTDC's ROCE Trend?

The trend of ROCE doesn't look fantastic because it's fallen from 2.2% five years ago, while the business's capital employed increased by 190%. Usually this isn't ideal, but given NEXTDC conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. NEXTDC probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by NEXTDC's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 74% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing: We've identified 3 warning signs with NEXTDC (at least 1 which is significant) , and understanding them would certainly be useful.

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.

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

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.