Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we’d want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after briefly looking over the numbers, we don’t think NVIDIA (NASDAQ:NVDA) has the makings of a multi-bagger going forward, but let’s have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on NVIDIA is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.16 = US$5.6b ÷ (US$41b – US$6.6b) (Based on the trailing twelve months to January 2023).
So, NVIDIA has an ROCE of 16%. That’s a relatively normal return on capital, and it’s around the 14% generated by the Semiconductor industry.
View our latest analysis for NVIDIA
In the above chart we have measured NVIDIA’s 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.
The Trend Of ROCE
On the surface, the trend of ROCE at NVIDIA doesn’t inspire confidence. Over the last five years, returns on capital have decreased to 16% from 32% five years ago. However it looks like NVIDIA might be reinvesting for long term growth because while capital employed has increased, the company’s sales haven’t changed much in the last 12 months. It’s worth keeping an eye on the company’s earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line
Bringing it all together, while we’re somewhat encouraged by NVIDIA’s reinvestment in its own business, we’re aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 372% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn’t get our hopes up too high.
If you want to continue researching NVIDIA, you might be interested to know about the 3 warning signs that our analysis has discovered.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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