To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. So on that note, EMCORE (NASDAQ:EMKR) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for EMCORE:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.082 = US$13m ÷ (US$188m - US$27m) (Based on the trailing twelve months to March 2022).
So, EMCORE has an ROCE of 8.2%. On its own, that's a low figure but it's around the 9.0% average generated by the Communications industry.
Above you can see how the current ROCE for EMCORE 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 EMCORE here for free.
What Does the ROCE Trend For EMCORE Tell Us?
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 8.2%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 40%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Bottom Line
In summary, it's great to see that EMCORE can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Astute investors may have an opportunity here because the stock has declined 69% in the last five years. So researching this company further and determining whether or not these trends will continue seems justified.
If you'd like to know more about EMCORE, we've spotted 2 warning signs, and 1 of them is a bit concerning.
While EMCORE may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.