To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Rambus' (NASDAQ:RMBS) 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. Analysts use this formula to calculate it for Rambus:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.071 = US$78m ÷ (US$1.2b - US$84m) (Based on the trailing twelve months to September 2023).
So, Rambus has an ROCE of 7.1%. In absolute terms, that's a low return and it also under-performs the Semiconductor industry average of 10%.
See our latest analysis for Rambus
In the above chart we have measured Rambus' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Rambus Tell Us?
We're delighted to see that Rambus is reaping rewards from its investments and has now broken into profitability. The company now earns 7.1% on its capital, because five years ago it was incurring losses. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. Because in the end, a business can only get so efficient.
In Conclusion...
In summary, we're delighted to see that Rambus has been able to increase efficiencies and earn higher rates of return on the same amount of capital. And a remarkable 685% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Rambus (of which 2 are a bit concerning!) that you should know about.
While Rambus isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.