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What are the early trends we should look for to identify a stock that could 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. Although, when we looked at NVE (NASDAQ:NVEC), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on NVE is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = US$13m ÷ (US$74m - US$749k) (Based on the trailing twelve months to December 2020).
Therefore, NVE has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 9.9% generated by the Semiconductor industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how NVE has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
So How Is NVE's ROCE Trending?
We're a bit concerned with the trends, because the business is applying 27% less capital than it was five years ago and returns on that capital have stayed flat. When a company effectively decreases its assets base, it's not usually a sign to be optimistic on that company. So if this trend continues, don't be surprised if the business is smaller in a few years time.
What We Can Learn From NVE's ROCE
Overall, we're not ecstatic to see NVE reducing the amount of capital it employs in the business. Although the market must be expecting these trends to improve because the stock has gained 83% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
On a separate note, we've found 2 warning signs for NVE you'll probably want to know about.
While NVE 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. 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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