Be Wary Of Power Integrations (NASDAQ:POWI) And Its Returns On Capital
If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Power Integrations (NASDAQ:POWI) and its ROCE trend, we weren't exactly thrilled.
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. The formula for this calculation on Power Integrations is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = US$57m ÷ (US$865m - US$53m) (Based on the trailing twelve months to September 2023).
So, Power Integrations has an ROCE of 7.0%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 10%.
See our latest analysis for Power Integrations
In the above chart we have measured Power Integrations' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Power Integrations here for free.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Power Integrations, we didn't gain much confidence. Around five years ago the returns on capital were 11%, but since then they've fallen to 7.0%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
Our Take On Power Integrations' ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Power Integrations have fallen, meanwhile the business is employing more capital than it was five years ago. Since the stock has skyrocketed 128% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
Like most companies, Power Integrations does come with some risks, and we've found 2 warning signs that you should be aware of.
While Power Integrations 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.
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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.
