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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. With that in mind, we've noticed some promising trends at Deswell Industries (NASDAQ:DSWL) so let's look a bit deeper.
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. Analysts use this formula to calculate it for Deswell Industries:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.014 = US$1.1m ÷ (US$100m - US$19m) (Based on the trailing twelve months to September 2020).
So, Deswell Industries has an ROCE of 1.4%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 11%.
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 Deswell Industries has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
Deswell Industries has broken into the black (profitability) and we're sure it's a sight for sore eyes. The company now earns 1.4% on its capital, because five years ago it was incurring losses. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
The Key Takeaway
To sum it up, Deswell Industries is collecting higher returns from the same amount of capital, and that's impressive. And a remarkable 168% total return over the last five years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
One more thing, we've spotted 2 warning signs facing Deswell Industries that you might find interesting.
While Deswell Industries isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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