If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Although, when we looked at Power Integrations (NASDAQ:POWI), it didn't seem to tick all of these boxes.
What Is 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 Power Integrations, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = US$57m ÷ (US$865m - US$53m) (Based on the trailing twelve months to September 2023).
Therefore, Power Integrations has an ROCE of 7.0%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 10%.
In the above chart we have measured Power Integrations' 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.
So How Is Power Integrations' ROCE 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 7.0% from 11% 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.
The Key Takeaway
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. Since the stock has skyrocketed 131% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
On a final note, we've found 2 warning signs for Power Integrations that we think you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.