If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. However, after briefly looking over the numbers, we don't think Ultra Clean Holdings (NASDAQ:UCTT) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What Is It?
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 Ultra Clean Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.048 = US$75m ÷ (US$1.8b - US$294m) (Based on the trailing twelve months to September 2023).
Therefore, Ultra Clean Holdings has an ROCE of 4.8%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 10%.
Above you can see how the current ROCE for Ultra Clean Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Ultra Clean Holdings.
What Can We Tell From Ultra Clean Holdings' ROCE Trend?
In terms of Ultra Clean Holdings' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 8.9%, but since then they've fallen to 4.8%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
The Bottom Line
We're a bit apprehensive about Ultra Clean Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Since the stock has skyrocketed 249% 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.
Ultra Clean Holdings does have some risks though, and we've spotted 2 warning signs for Ultra Clean Holdings that you might be interested in.
While Ultra Clean 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.