NVIDIA (NASDAQ:NVDA) Could Be Struggling To Allocate Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at NVIDIA (NASDAQ:NVDA), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

What Is 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. Analysts use this formula to calculate it for NVIDIA:

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

0.22 = US$7.3b ÷ (US$40b - US$6.9b) (Based on the trailing twelve months to October 2022).

Therefore, NVIDIA has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.

See our latest analysis for NVIDIA

Above you can see how the current ROCE for NVIDIA 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 NVIDIA here for free.

How Are Returns Trending?

In terms of NVIDIA's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 33%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that NVIDIA is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 243% to shareholders in the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

If you want to continue researching NVIDIA, you might be interested to know about the 3 warning signs that our analysis has discovered.

NVIDIA 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.

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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.