Here’s What’s Happening With Returns At NeoPhotonics (NYSE:NPTN)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, NeoPhotonics (NYSE:NPTN) looks quite promising in regards to its trends of return on capital.

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 NeoPhotonics, this is the formula:

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

0.068 = US$16m ÷ (US$346m - US$109m) (Based on the trailing twelve months to September 2020).

Therefore, NeoPhotonics has an ROCE of 6.8%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 10%.

View our latest analysis for NeoPhotonics

In the above chart we have measured NeoPhotonics' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for NeoPhotonics.

How Are Returns Trending?

NeoPhotonics is showing promise given that its ROCE is trending up and to the right. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 127% in that same time. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

The Key Takeaway

To bring it all together, NeoPhotonics has done well to increase the returns it's generating from its capital employed. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 6.2% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

If you'd like to know more about NeoPhotonics, we've spotted 3 warning signs, and 1 of them makes us a bit uncomfortable.

While NeoPhotonics may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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This article by Simply Wall St is general in nature. 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.
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