If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Arm Holdings (NASDAQ:ARM) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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 Arm Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.022 = US$148m ÷ (US$7.9b - US$1.1b) (Based on the trailing twelve months to June 2024).
So, Arm Holdings has an ROCE of 2.2%. In absolute terms, that's a low return and it also under-performs the Semiconductor industry average of 9.0%.
In the above chart we have measured Arm Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Arm Holdings .
The Trend Of ROCE
In terms of Arm Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 13% over the last two years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
What We Can Learn From Arm Holdings' ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Arm Holdings. And the stock has done incredibly well with a 176% return over the last year, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
Like most companies, Arm Holdings does come with some risks, and we've found 2 warning signs that you should be aware of.
While Arm Holdings 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.
