If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at SG Micro (SZSE:300661), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on SG Micro is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = CN¥154m ÷ (CN¥4.5b - CN¥536m) (Based on the trailing twelve months to September 2023).
So, SG Micro has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Semiconductor industry average of 5.6%.
Above you can see how the current ROCE for SG Micro compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering SG Micro for free.
What Does the ROCE Trend For SG Micro Tell Us?
When we looked at the ROCE trend at SG Micro, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 3.9% from 11% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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.
What We Can Learn From SG Micro's ROCE
In summary, we're somewhat concerned by SG Micro's diminishing returns on increasing amounts of capital. Since the stock has skyrocketed 344% 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.
One final note, you should learn about the 2 warning signs we've spotted with SG Micro (including 1 which is a bit concerning) .
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.