To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. With that in mind, we've noticed some promising trends at NXP Semiconductors (NASDAQ:NXPI) so let's look a bit deeper.
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. To calculate this metric for NXP Semiconductors, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = US$3.9b ÷ (US$23b - US$3.3b) (Based on the trailing twelve months to December 2022).
Therefore, NXP Semiconductors has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Semiconductor industry average of 15% it's much better.
In the above chart we have measured NXP Semiconductors' 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 NXP Semiconductors here for free.
The Trend Of ROCE
NXP Semiconductors has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 682% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
The Key Takeaway
As discussed above, NXP Semiconductors appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And with a respectable 61% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. 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 NXP Semiconductors that you might find interesting.
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.
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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.
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