There are a few key trends to look for if we want to identify the next multi-bagger. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. That's why when we briefly looked at Nova's (NASDAQ:NVMI) ROCE trend, we were pretty happy with what we saw.
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. Analysts use this formula to calculate it for Nova:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$134m ÷ (US$1.2b - US$338m) (Based on the trailing twelve months to March 2024).
So, Nova has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 9.7% generated by the Semiconductor industry.
Above you can see how the current ROCE for Nova 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 Nova for free.
What Can We Tell From Nova's ROCE Trend?
While the returns on capital are good, they haven't moved much. The company has consistently earned 16% for the last five years, and the capital employed within the business has risen 166% in that time. Since 16% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 28% of total assets, this reported ROCE would probably be less than16% because total capital employed would be higher.The 16% ROCE could be even lower if current liabilities weren't 28% of total assets, because the the formula would show a larger base of total capital employed. So while current liabilities isn't high right now, keep an eye out in case it increases further, because this can introduce some elements of risk.
The Bottom Line
The main thing to remember is that Nova has proven its ability to continually reinvest at respectable rates of return. On top of that, the stock has rewarded shareholders with a remarkable 677% return to those who've held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
Nova could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation for NVMI on our platform quite valuable.
While Nova isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.