To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 investigating Silicom (NASDAQ:SILC), we don't think it's current trends fit the mold of a multi-bagger.
Understanding 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 Silicom:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = US$9.3m ÷ (US$203m - US$34m) (Based on the trailing twelve months to March 2021).
So, Silicom has an ROCE of 5.5%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 7.9%.
In the above chart we have measured Silicom'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 report for Silicom.
How Are Returns Trending?
In terms of Silicom's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 11%, but since then they've fallen to 5.5%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
What We Can Learn From Silicom's ROCE
While returns have fallen for Silicom in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 45% to shareholders over the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.
If you'd like to know about the risks facing Silicom, we've discovered 1 warning sign that you should be aware of.
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.
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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