This article is intended for those of you who are at the beginning of your investing journey and looking to gauge the potential return on investment in Broadcom Inc (NASDAQ:AVGO).
Broadcom stock represents an ownership share in the company. Your equity share is granted in return for the capital provided to the business to operate, and in order for an investment to be successful the business has to create earnings from the funds that make up this capital. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Therefore, looking at how efficiently Broadcom is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
View our latest analysis for Broadcom
Calculating Return On Capital Employed for AVGO
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Broadcom is good at growing investor capital. AVGO’s ROCE is calculated below:
ROCE Calculation for AVGO
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$4.4b ÷ (US$50.4b – US$2.2b) = 9.1%
As you can see, AVGO earned $9.1 from every $100 you invested over the previous twelve months. Comparing this to a healthy 15% benchmark shows Broadcom is currently unable to return a satisfactory amount to owners for the use of their capital, which isn’t good for investors who have forgone other potentially solid companies.
A deeper look
The underperforming ROCE is not ideal for Broadcom investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, AVGO’s ROCE may increase, in which case your portfolio could benefit from holding the company. Therefore, investors need to understand the trend of the inputs in the formula above, so that they can see if there is an opportunity to invest. If you go back three years, you’ll find that AVGO’s ROCE has decreased from 19%. We can see that earnings have actually increased from US$1.7b to US$4.4b but capital employed rose by a proportionally greater amount due to an increase in total assets , which suggests investor’s ROCE has fallen because the company requires more capital to create earnings despite the previous growth in EBT.
Next Steps
Broadcom’s ROCE has decreased in the recent past and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for AVGO’s future growth? Take a look at our free research report of analyst consensus for AVGO’s outlook.
- Valuation: What is AVGO worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether AVGO is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.