Microchip Technology (NASDAQ:MCHP) Could Become A Multi-Bagger

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. And in light of that, the trends we're seeing at Microchip Technology's (NASDAQ:MCHP) look very promising so lets take a look.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Microchip Technology, this is the formula:

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

0.25 = US$3.2b ÷ (US$16b - US$3.3b) (Based on the trailing twelve months to December 2023).

Thus, Microchip Technology has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Semiconductor industry average of 9.7%.

Check out our latest analysis for Microchip Technology

In the above chart we have measured Microchip Technology'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 analyst report for Microchip Technology .

What The Trend Of ROCE Can Tell Us

You'd find it hard not to be impressed with the ROCE trend at Microchip Technology. The figures show that over the last five years, returns on capital have grown by 291%. The company is now earning US$0.2 per dollar of capital employed. Interestingly, the business may be becoming more efficient because it's applying 27% less capital than it was five years ago. Microchip Technology may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 20% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line On Microchip Technology's ROCE

In summary, it's great to see that Microchip Technology has been able to turn things around and earn higher returns on lower amounts of capital. And a remarkable 101% total return over the last five years tells us that investors are expecting more good things to come in the future. Therefore, we think it would be worth your time to check if these trends are going to continue.

Microchip Technology does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is significant...

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.