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Tower Semiconductor's (NASDAQ:TSEM) Returns On Capital Not Reflecting Well On The Business

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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? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. 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 Tower Semiconductor (NASDAQ:TSEM) 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)

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 Tower Semiconductor is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.065 = US$119m ÷ (US$2.1b - US$303m) (Based on the trailing twelve months to June 2021).

Thus, Tower Semiconductor has an ROCE of 6.5%. In absolute terms, that's a low return and it also under-performs the Semiconductor industry average of 13%.

View our latest analysis for Tower Semiconductor

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Above you can see how the current ROCE for Tower Semiconductor compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

In terms of Tower Semiconductor's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 12%, but since then they've fallen to 6.5%. 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 Tower Semiconductor 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 96% 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.

While Tower Semiconductor doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.