Should We Be Excited About The Trends Of Returns At Novanta (NASDAQ:NOVT)?

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. However, after briefly looking over the numbers, we don't think Novanta (NASDAQ:NOVT) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Novanta, this is the formula:

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

0.087 = US$63m ÷ (US$858m - US$134m) (Based on the trailing twelve months to October 2020).

So, Novanta has an ROCE of 8.7%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 12%.

View our latest analysis for Novanta

Above you can see how the current ROCE for Novanta compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

There are better returns on capital out there than what we're seeing at Novanta. Over the past five years, ROCE has remained relatively flat at around 8.7% and the business has deployed 98% more capital into its operations. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

Our Take On Novanta's ROCE

In summary, Novanta has simply been reinvesting capital and generating the same low rate of return as before. Yet to long term shareholders the stock has gifted them an incredible 1,015% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing to note, we've identified 2 warning signs with Novanta and understanding these should be part of your investment process.

While Novanta 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. 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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