To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in Monolithic Power Systems' (NASDAQ:MPWR) returns on capital, so let's have a look.

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. To calculate this metric for Monolithic Power Systems, this is the formula:

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

0.22 = US$482m ÷ (US$2.4b - US$235m) (Based on the trailing twelve months to December 2023).

Therefore, Monolithic Power Systems has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 10% earned by companies in a similar industry.

Above you can see how the current ROCE for Monolithic Power Systems compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Monolithic Power Systems .

What The Trend Of ROCE Can Tell Us

Investors would be pleased with what's happening at Monolithic Power Systems. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 22%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 208%. So we're very much inspired by what we're seeing at Monolithic Power Systems thanks to its ability to profitably reinvest capital.

What We Can Learn From Monolithic Power Systems' ROCE

In summary, it's great to see that Monolithic Power Systems can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And a remarkable 440% total return over the last five years tells us that investors are expecting more good things to come in the future. Therefore, we think it would be worth your time to check if these trends are going to continue.

On a separate note, we've found 2 warning signs for Monolithic Power Systems you'll probably want to know about.

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.

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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.