If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Speaking of which, we noticed some great changes in Lam Research's (NASDAQ:LRCX) returns on capital, so let's have 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. To calculate this metric for Lam Research, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.41 = US$5.2b ÷ (US$17b - US$3.9b) (Based on the trailing twelve months to December 2021).
Therefore, Lam Research has an ROCE of 41%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.
Above you can see how the current ROCE for Lam Research compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Lam Research here for free.
So How Is Lam Research's ROCE Trending?
Lam Research is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 41%. Basically the business is earning more per dollar of capital invested and in addition to that, 45% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
Our Take On Lam Research's ROCE
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Lam Research has. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Lam Research can keep these trends up, it could have a bright future ahead.
Lam Research does have some risks though, and we've spotted 1 warning sign for Lam Research that you might be interested in.
Lam Research is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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.