What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Harmonic (NASDAQ:HLIT) and its trend of ROCE, we really liked what we saw.
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. The formula for this calculation on Harmonic is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.064 = US$28m ÷ (US$592m - US$147m) (Based on the trailing twelve months to December 2020).
Therefore, Harmonic has an ROCE of 6.4%. Ultimately, that's a low return and it under-performs the Communications industry average of 8.9%.
In the above chart we have measured Harmonic'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 Harmonic here for free.
So How Is Harmonic's ROCE Trending?
Harmonic has broken into the black (profitability) and we're sure it's a sight for sore eyes. While the business was unprofitable in the past, it's now turned things around and is earning 6.4% on its capital. While returns have increased, the amount of capital employed by Harmonic has remained flat over the period. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. Because in the end, a business can only get so efficient.
What We Can Learn From Harmonic's ROCE
As discussed above, Harmonic appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has returned a staggering 132% to shareholders over the last five years, it looks like investors are recognizing these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
One more thing, we've spotted 2 warning signs facing Harmonic that you might find interesting.
While Harmonic 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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What are the risks and opportunities for Harmonic?
Earnings are forecast to grow 56.6% per year
Earnings grew by 112.6% over the past year
Shareholders have been diluted in the past year
Significant insider selling over the past 3 months
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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