If you're looking for a multi-bagger, there's a few things to keep an eye out 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in Semtech's (NASDAQ:SMTC) 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 Semtech, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.089 = US$87m ÷ (US$1.1b - US$97m) (Based on the trailing twelve months to May 2021).
So, Semtech has an ROCE of 8.9%. On its own, that's a low figure but it's around the 11% average generated by the Semiconductor industry.
In the above chart we have measured Semtech's 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 Semtech here for free.
So How Is Semtech's ROCE Trending?
Semtech is showing promise given that its ROCE is trending up and to the right. The figures show that over the last five years, ROCE has grown 121% whilst employing roughly the same amount of capital. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
The Key Takeaway
To bring it all together, Semtech has done well to increase the returns it's generating from its capital employed. Since the stock has returned a staggering 179% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Semtech can keep these trends up, it could have a bright future ahead.
Like most companies, Semtech does come with some risks, and we've found 1 warning sign that you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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