What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Alpha and Omega Semiconductor's (NASDAQ:AOSL) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Alpha and Omega Semiconductor, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.00036 = US$355k ÷ (US$1.2b - US$160m) (Based on the trailing twelve months to March 2024).
So, Alpha and Omega Semiconductor has an ROCE of 0.04%. In absolute terms, that's a low return and it also under-performs the Semiconductor industry average of 9.5%.
In the above chart we have measured Alpha and Omega Semiconductor's 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 Alpha and Omega Semiconductor for free.
What The Trend Of ROCE Can Tell Us
Alpha and Omega Semiconductor has recently broken into profitability so their prior investments seem to be paying off. About five years ago the company was generating losses but things have turned around because it's now earning 0.04% on its capital. Not only that, but the company is utilizing 75% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
Our Take On Alpha and Omega Semiconductor's ROCE
Long story short, we're delighted to see that Alpha and Omega Semiconductor's reinvestment activities have paid off and the company is now profitable. Since the stock has returned a staggering 264% to shareholders over the last five years, it looks like investors are recognizing these changes. 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 to note, we've identified 1 warning sign with Alpha and Omega Semiconductor and understanding this should be part of your investment process.
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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