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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? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Silicon Motion Technology (NASDAQ:SIMO) 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?
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 Silicon Motion Technology is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$101m ÷ (US$730m - US$109m) (Based on the trailing twelve months to September 2020).
So, Silicon Motion Technology has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Semiconductor industry average of 10% it's much better.
In the above chart we have measured Silicon Motion Technology's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Silicon Motion Technology's ROCE Trending?
On the surface, the trend of ROCE at Silicon Motion Technology doesn't inspire confidence. To be more specific, ROCE has fallen from 21% over the last five years. 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. If these investments prove successful, this can bode very well for long term stock performance.
The Bottom Line On Silicon Motion Technology's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Silicon Motion Technology is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 87% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.
Like most companies, Silicon Motion Technology does come with some risks, and we've found 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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