What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. In light of that, when we looked at Semtech (NASDAQ:SMTC) and its ROCE trend, we weren't exactly thrilled.
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Semtech:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.062 = US$71m ÷ (US$1.4b - US$283m) (Based on the trailing twelve months to January 2025).
So, Semtech has an ROCE of 6.2%. In absolute terms, that's a low return but it's around the Semiconductor industry average of 7.1%.
View our latest analysis for Semtech
In the above chart we have measured Semtech's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Semtech .
Over the past five years, Semtech's ROCE and capital employed have both remained mostly flat. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So unless we see a substantial change at Semtech in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger.
On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 20% of total assets, this reported ROCE would probably be less than6.2% because total capital employed would be higher.The 6.2% ROCE could be even lower if current liabilities weren't 20% of total assets, because the the formula would show a larger base of total capital employed. So while current liabilities isn't high right now, keep an eye out in case it increases further, because this can introduce some elements of risk.
In summary, Semtech isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Unsurprisingly, the stock has only gained 21% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Semtech (of which 1 can't be ignored!) that you should know about.
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.
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