What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Power Integrations (NASDAQ:POWI), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What Is It?
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. To calculate this metric for Power Integrations, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.025 = US$19m ÷ (US$805m - US$50m) (Based on the trailing twelve months to June 2024).
So, Power Integrations has an ROCE of 2.5%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 9.0%.
Above you can see how the current ROCE for Power Integrations 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 Power Integrations for free.
How Are Returns Trending?
In terms of Power Integrations' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 2.5% from 7.4% five years ago. 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.
What We Can Learn From 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. In spite of that, the stock has delivered a 33% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
One more thing, we've spotted 1 warning sign facing Power Integrations 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.