There are a few key trends to look for if we want to identify the next multi-bagger. 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. With that in mind, we've noticed some promising trends at Rapid7 (NASDAQ:RPD) so let's look a bit deeper.

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. The formula for this calculation on Rapid7 is:

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

0.041 = US$39m ÷ (US$1.5b - US$579m) (Based on the trailing twelve months to June 2024).

Therefore, Rapid7 has an ROCE of 4.1%. Ultimately, that's a low return and it under-performs the Software industry average of 9.1%.

View our latest analysis for Rapid7

In the above chart we have measured Rapid7'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 Rapid7 .

The Trend Of ROCE

The fact that Rapid7 is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 4.1% on its capital. And unsurprisingly, like most companies trying to break into the black, Rapid7 is utilizing 146% more capital than it was five years ago. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

The Bottom Line

Overall, Rapid7 gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Given the stock has declined 22% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. With that in mind, we believe the promising trends warrant this stock for further investigation.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Rapid7 (of which 1 can't be ignored!) that 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.

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.