There Are Reasons To Feel Uneasy About IQE's (LON:IQE) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. However, after investigating IQE (LON:IQE), we don't think it's current trends fit the mold of a multi-bagger.

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 IQE is:

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

0.016 = UK£5.3m ÷ (UK£371m - UK£49m) (Based on the trailing twelve months to December 2020).

So, IQE has an ROCE of 1.6%. In absolute terms, that's a low return and it also under-performs the Semiconductor industry average of 5.5%.

Check out our latest analysis for IQE

In the above chart we have measured IQE's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For IQE Tell Us?

In terms of IQE's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 8.7% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line On IQE's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for IQE. And long term investors must be optimistic going forward because the stock has returned a huge 188% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

IQE does have some risks though, and we've spotted 1 warning sign for IQE that you might be interested in.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. 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.
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