There Are Reasons To Feel Uneasy About Nova's (NASDAQ:NVMI) Returns On Capital
To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 Nova (NASDAQ:NVMI) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What Is It?
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. The formula for this calculation on Nova is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = US$153m ÷ (US$984m - US$134m) (Based on the trailing twelve months to December 2022).
Thus, Nova has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 14% generated by the Semiconductor industry.
Check out our latest analysis for Nova
Above you can see how the current ROCE for Nova 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 Nova here for free.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Nova, we didn't gain much confidence. To be more specific, ROCE has fallen from 25% 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that Nova is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 290% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
One more thing to note, we've identified 1 warning sign with Nova and understanding this should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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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