Semtech (NASDAQ:SMTC) Shareholders Will Want The ROCE Trajectory To Continue

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in Semtech's (NASDAQ:SMTC) returns on capital, so let's have a look.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for Semtech:

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

0.13 = US$175m ÷ (US$1.5b - US$140m) (Based on the trailing twelve months to October 2022).

Therefore, Semtech has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Semiconductor industry average of 14%.

See our latest analysis for Semtech

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

What The Trend Of ROCE Can Tell Us

Semtech is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 13%. The amount of capital employed has increased too, by 39%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

The Bottom Line

In summary, it's great to see that Semtech can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Astute investors may have an opportunity here because the stock has declined 13% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

Like most companies, Semtech does come with some risks, and we've found 1 warning sign that you should be aware of.

While Semtech isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.