Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Ergo, when we looked at the ROCE trends at NVIDIA (NASDAQ:NVDA), we liked what we saw.
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. Analysts use this formula to calculate it for NVIDIA:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = US$5.7b ÷ (US$31b - US$4.0b) (Based on the trailing twelve months to May 2021).
Thus, NVIDIA has an ROCE of 21%. That's a fantastic return and not only that, it outpaces the average of 11% earned by companies in a similar industry.
Above you can see how the current ROCE for NVIDIA 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 NVIDIA here for free.
So How Is NVIDIA's ROCE Trending?
NVIDIA deserves to be commended in regards to it's returns. The company has consistently earned 21% for the last five years, and the capital employed within the business has risen 465% in that time. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 13% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.
In Conclusion...
NVIDIA has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. And long term investors would be thrilled with the 1,292% return they've received over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
On a final note, we've found 2 warning signs for NVIDIA that we think you should be aware of.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
This article by Simply Wall St is general in nature. 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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