Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Power Integrations (NASDAQ:POWI), it didn't seem to tick all of these boxes.

What Is 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. To calculate this metric for Power Integrations, this is the formula:

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

0.039 = US$30m ÷ (US$806m - US$50m) (Based on the trailing twelve months to March 2024).

Therefore, Power Integrations has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 8.9%.

See our latest analysis for Power Integrations

Above you can see how the current ROCE for Power Integrations 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 Power Integrations .

How Are Returns Trending?

On the surface, the trend of ROCE at Power Integrations doesn't inspire confidence. Around five years ago the returns on capital were 8.7%, but since then they've fallen to 3.9%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

Our Take On Power Integrations' ROCE

We're a bit apprehensive about Power Integrations because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these concerning fundamentals, the stock has performed strongly with a 71% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing to note, we've identified 2 warning signs with Power Integrations and understanding these should be part of your investment process.