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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at NVE (NASDAQ:NVEC) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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. The formula for this calculation on NVE is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = US$14m ÷ (US$79m - US$1.2m) (Based on the trailing twelve months to June 2020).
Therefore, NVE has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 9.7% generated by the Semiconductor industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for NVE's ROCE against it's prior returns. 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.
What Does the ROCE Trend For NVE Tell Us?
We've noticed that although returns on capital are flat over the last five years, the amount of capital employed in the business has fallen 27% in that same period. This indicates to us that assets are being sold and thus the business is likely shrinking, which you'll remember isn't the typical ingredients for an up-and-coming multi-bagger. So if this trend continues, don't be surprised if the business is smaller in a few years time.
The Bottom Line On NVE's ROCE
Overall, we're not ecstatic to see NVE reducing the amount of capital it employs in the business. Since the stock has gained an impressive 42% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
If you'd like to know about the risks facing NVE, we've discovered 2 warning signs that you should be aware of.
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.
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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