Capital Allocation Trends At NVIDIA (NASDAQ:NVDA) Aren't Ideal
What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at NVIDIA (NASDAQ:NVDA), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
Return On Capital Employed (ROCE): What Is It?
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 NVIDIA, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.22 = US$7.3b ÷ (US$40b - US$6.9b) (Based on the trailing twelve months to October 2022).
So, NVIDIA has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Semiconductor industry average of 15%.
Check out our latest analysis for NVIDIA
In the above chart we have measured NVIDIA'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 NVIDIA here for free.
So How Is NVIDIA's ROCE Trending?
When we looked at the ROCE trend at NVIDIA, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 33%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
What We Can Learn From NVIDIA's 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 NVIDIA. And the stock has done incredibly well with a 267% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.
If you'd like to know about the risks facing NVIDIA, we've discovered 3 warning signs that you should be aware of.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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.
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