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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at IPG Photonics (NASDAQ:IPGP) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding 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. To calculate this metric for IPG Photonics, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.085 = US$232m ÷ (US$2.9b - US$215m) (Based on the trailing twelve months to December 2020).
So, IPG Photonics has an ROCE of 8.5%. Ultimately, that's a low return and it under-performs the Electronic industry average of 11%.
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 to see what analysts are forecasting going forward, you should check out our free report for IPG Photonics.
What Does the ROCE Trend For IPG Photonics Tell Us?
When we looked at the ROCE trend at IPG Photonics, we didn't gain much confidence. Around five years ago the returns on capital were 26%, but since then they've fallen to 8.5%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
What We Can Learn From IPG Photonics' ROCE
To conclude, we've found that IPG Photonics is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 125% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Like most companies, IPG Photonics does come with some risks, and we've found 1 warning sign that you should be aware of.
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. 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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