If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Amlogic (Shanghai)Ltd (SHSE:688099), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Amlogic (Shanghai)Ltd, this is the formula:

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

0.047 = CN¥271m ÷ (CN¥6.6b - CN¥911m) (Based on the trailing twelve months to March 2024).

Thus, Amlogic (Shanghai)Ltd has an ROCE of 4.7%. In absolute terms, that's a low return, but it's much better than the Semiconductor industry average of 3.9%.

In the above chart we have measured Amlogic (Shanghai)Ltd'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 Amlogic (Shanghai)Ltd for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Amlogic (Shanghai)Ltd, we didn't gain much confidence. Around five years ago the returns on capital were 22%, but since then they've fallen to 4.7%. 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.

On a side note, Amlogic (Shanghai)Ltd has done well to pay down its current liabilities to 14% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Amlogic (Shanghai)Ltd's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Amlogic (Shanghai)Ltd. And there could be an opportunity here if other metrics look good too, because the stock has declined 34% in the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Like most companies, Amlogic (Shanghai)Ltd does come with some risks, and we've found 1 warning sign that you should be aware of.

While Amlogic (Shanghai)Ltd isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.