Silicom's (NASDAQ:SILC) Returns On Capital Not Reflecting Well On The Business
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Silicom (NASDAQ:SILC) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding Return On Capital Employed (ROCE)
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 Silicom is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = US$9.3m ÷ (US$203m - US$34m) (Based on the trailing twelve months to March 2021).
Therefore, Silicom has an ROCE of 5.5%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 8.2%.
See our latest analysis for Silicom
In the above chart we have measured Silicom'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.
What Does the ROCE Trend For Silicom Tell Us?
When we looked at the ROCE trend at Silicom, we didn't gain much confidence. Around five years ago the returns on capital were 11%, but since then they've fallen to 5.5%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
In Conclusion...
While returns have fallen for Silicom in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 54% 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.
One more thing: We've identified 3 warning signs with Silicom (at least 1 which makes us a bit uncomfortable) , and understanding these would certainly be useful.
While Silicom may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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