To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. And in light of that, the trends we're seeing at Applied Materials' (NASDAQ:AMAT) look very promising so lets take a look.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Applied Materials is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = US$4.5b ÷ (US$22b - US$4.5b) (Based on the trailing twelve months to October 2020).
Therefore, Applied Materials has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Semiconductor industry average of 10%.
In the above chart we have measured Applied Materials' 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 Applied Materials here for free.
The Trend Of ROCE
The trends we've noticed at Applied Materials are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 25%. Basically the business is earning more per dollar of capital invested and in addition to that, 56% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
The Bottom Line On Applied Materials' ROCE
To sum it up, Applied Materials has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And a remarkable 392% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
On a final note, we've found 3 warning signs for Applied Materials that we think you should be aware of.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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