Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, Microchip Technology (NASDAQ:MCHP) looks quite promising in regards to its trends of return on capital.

What Is Return On Capital Employed (ROCE)?

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. To calculate this metric for Microchip Technology, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.092 = US$1.1b ÷ (US$16b - US$3.3b) (Based on the trailing twelve months to September 2024).

So, Microchip Technology has an ROCE of 9.2%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.6%.

In the above chart we have measured Microchip Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Microchip Technology for free.

What The Trend Of ROCE Can Tell Us

Microchip Technology has not disappointed in regards to ROCE growth. The data shows that returns on capital have increased by 59% over the trailing five years. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Speaking of capital employed, the company is actually utilizing 20% less than it was five years ago, which can be indicative of a business that's improving its efficiency. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

The Bottom Line

In the end, Microchip Technology has proven it's capital allocation skills are good with those higher returns from less amount of capital. Considering the stock has delivered 22% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

One more thing, we've spotted 3 warning signs facing Microchip Technology that you might find interesting.

While Microchip Technology 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.