What are the early trends we should look for to identify a stock that could 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. And in light of that, the trends we're seeing at Rectifier Technologies' (ASX:RFT) look very promising so lets take a look.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Rectifier Technologies:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.29 = AU$4.9m ÷ (AU$30m - AU$13m) (Based on the trailing twelve months to December 2022).

Therefore, Rectifier Technologies has an ROCE of 29%. That's a fantastic return and not only that, it outpaces the average of 5.1% earned by companies in a similar industry.

View our latest analysis for Rectifier Technologies

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Rectifier Technologies has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

We like the trends that we're seeing from Rectifier Technologies. The data shows that returns on capital have increased substantially over the last five years to 29%. Basically the business is earning more per dollar of capital invested and in addition to that, 126% more capital is being employed now too. So we're very much inspired by what we're seeing at Rectifier Technologies thanks to its ability to profitably reinvest capital.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 43% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

What We Can Learn From Rectifier Technologies' ROCE

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Rectifier Technologies has. Since the stock has returned a solid 84% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. In light of that, we think it's worth looking further into this stock because if Rectifier Technologies can keep these trends up, it could have a bright future ahead.

One more thing, we've spotted 1 warning sign facing Rectifier Technologies that you might find interesting.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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