What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. So when we looked at Texas Instruments (NASDAQ:TXN), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
What Is 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. Analysts use this formula to calculate it for Texas Instruments:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.30 = US$8.6b ÷ (US$31b - US$2.7b) (Based on the trailing twelve months to June 2023).
Therefore, Texas Instruments has an ROCE of 30%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.
Above you can see how the current ROCE for Texas Instruments 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 Texas Instruments here for free.
What Can We Tell From Texas Instruments' ROCE Trend?
When we looked at the ROCE trend at Texas Instruments, we didn't gain much confidence. Historically returns on capital were even higher at 39%, but they have dropped over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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.
Our Take On Texas Instruments' ROCE
Bringing it all together, while we're somewhat encouraged by Texas Instruments' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 67% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing: We've identified 2 warning signs with Texas Instruments (at least 1 which makes us a bit uncomfortable) , and understanding them would certainly be useful.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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.