If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at IPG Photonics (NASDAQ:IPGP), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for IPG Photonics:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$353m ÷ (US$3.2b - US$313m) (Based on the trailing twelve months to December 2021).
So, IPG Photonics has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Electronic industry average of 10%.
Above you can see how the current ROCE for IPG Photonics 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 IPG Photonics here for free.
How Are Returns Trending?
In terms of IPG Photonics' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 23% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
Our Take On IPG Photonics' ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for IPG Photonics. These trends are starting to be recognized by investors since the stock has delivered a 14% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
One more thing to note, we've identified 1 warning sign with IPG Photonics and understanding it should be part of your investment process.
While IPG Photonics 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.
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.