If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Allegro MicroSystems (NASDAQ:ALGM) and its trend of ROCE, we really liked what we saw.

Understanding 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. To calculate this metric for Allegro MicroSystems, this is the formula:

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

0.18 = US$255m ÷ (US$1.6b - US$120m) (Based on the trailing twelve months to December 2023).

So, Allegro MicroSystems has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 10% generated by the Semiconductor industry.

Above you can see how the current ROCE for Allegro MicroSystems compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Allegro MicroSystems' ROCE Trend?

Allegro MicroSystems is displaying some positive trends. The numbers show that in the last four years, the returns generated on capital employed have grown considerably to 18%. 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 118%. So we're very much inspired by what we're seeing at Allegro MicroSystems thanks to its ability to profitably reinvest capital.

Our Take On Allegro MicroSystems' ROCE

In summary, it's great to see that Allegro MicroSystems 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. And given the stock has remained rather flat over the last three years, there might be an opportunity here if other metrics are strong. With that in mind, we believe the promising trends warrant this stock for further investigation.

Like most companies, Allegro MicroSystems does come with some risks, and we've found 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.