If we want to find a stock that could multiply over the long term, what are the underlying trends we should be looking for? Among other things, we will want to see two things; first, growth come back on capital employed (ROCE) and on the other hand, an expansion of the amount capital employed. This shows us that it is a compounding machine, capable of continuously reinvesting its profits back into the business and generating higher returns. So when we looked Medical ShockWave (NASDAQ: SWAV) and its ROCE trend, we really liked what we saw.
Understanding return on capital employed (ROCE)
If you’ve never worked with ROCE before, it measures the “yield” (pre-tax profit) a company generates from the capital used in its business. Analysts use this formula to calculate it for ShockWave Medical:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.099 = $32 million ÷ ($373 million – $51 million) (Based on the last twelve months to March 2022).
Thereby, ShockWave Medical has a ROCE of 9.9%. In absolute terms, that’s a low return, but it’s around the medical equipment industry average of 8.9%.
In the graph above, we measured ShockWave Medical’s past ROCE against its past performance, but the future is arguably more important. If you want to see what analysts are predicting for the future, you should check out our free report for ShockWave Medical.
What the ROCE trend can tell us
The fact that ShockWave Medical is now generating pre-tax profits on its past investments is very encouraging. The company was generating losses four years ago, but is now earning 9.9%, which is a feast for the eyes. Not only that, but the company is using 517% more capital than before, but that’s to be expected of a company trying to become profitable. We like this trend because it tells us that the company has profitable reinvestment opportunities, and if it continues, it can lead to multi-bagger performance.
What We Can Learn From ShockWave Medical’s ROCE
Much to the delight of most shareholders, ShockWave Medical is now profitable. Given that the stock has returned 158% to shareholders over the past three years, it seems investors recognize these changes. So given that the stock has proven to have some promising trends, it’s worth researching the company further to see if those trends are likely to persist.
ShockWave Medical carries some risks, however, and we have spotted 3 Warning Signs for ShockWave Medical that might interest you.
If you want to look for strong companies with excellent earnings, check out this free list of companies with strong balance sheets and impressive returns on equity.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.