To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Arm Holdings (NASDAQ:ARM), 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 Arm Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.057 = US$408m ÷ (US$8.1b - US$899m) (Based on the trailing twelve months to September 2024).
Therefore, Arm Holdings has an ROCE of 5.7%. In absolute terms, that's a low return and it also under-performs the Semiconductor industry average of 8.6%.
Above you can see how the current ROCE for Arm Holdings 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 analyst report for Arm Holdings .
How Are Returns Trending?
On the surface, the trend of ROCE at Arm Holdings doesn't inspire confidence. To be more specific, ROCE has fallen from 13% over the last two years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
Our Take On Arm Holdings' 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 Arm Holdings. Furthermore the stock has climbed 80% over the last year, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.
If you'd like to know about the risks facing Arm Holdings, we've discovered 1 warning sign that you should be aware of.
While Arm Holdings 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.
