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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? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. However, after briefly looking over the numbers, we don't think Silicom (NASDAQ:SILC) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Silicom is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.071 = US$12m ÷ (US$207m - US$39m) (Based on the trailing twelve months to September 2021).
So, Silicom has an ROCE of 7.1%. Even though it's in line with the industry average of 7.1%, it's still a low return by itself.
Above you can see how the current ROCE for Silicom 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 Silicom here for free.
What Can We Tell From Silicom's ROCE Trend?
In terms of Silicom's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 9.6% 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 Silicom is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 26% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.
If you want to continue researching Silicom, you might be interested to know about the 1 warning sign that our analysis has discovered.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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