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There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, while the ROCE is currently high for Cirrus Logic (NASDAQ:CRUS), we aren't jumping out of our chairs because returns are decreasing.
Understanding Return On Capital Employed (ROCE)
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. The formula for this calculation on Cirrus Logic is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = US$370m ÷ (US$2.1b - US$265m) (Based on the trailing twelve months to March 2022).
So, Cirrus Logic has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Semiconductor industry average of 14%.
In the above chart we have measured Cirrus Logic's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
When we looked at the ROCE trend at Cirrus Logic, we didn't gain much confidence. Historically returns on capital were even higher at 26%, but they have dropped over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
What We Can Learn From Cirrus Logic's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Cirrus Logic is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 20% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
Cirrus Logic does have some risks, we noticed 3 warning signs (and 2 which are significant) we think you should know about.
Cirrus Logic is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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.