Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. With that in mind, we've noticed some promising trends at Deswell Industries (NASDAQ:DSWL) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Deswell Industries is:

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

0.04 = US$3.8m ÷ (US$111m - US$16m) (Based on the trailing twelve months to March 2024).

So, Deswell Industries has an ROCE of 4.0%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 10%.

Check out our latest analysis for Deswell Industries

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Deswell Industries' past further, check out this free graph covering Deswell Industries' past earnings, revenue and cash flow.

So How Is Deswell Industries' ROCE Trending?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 431% in that same time. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

In Conclusion...

In summary, we're delighted to see that Deswell Industries has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Considering the stock has delivered 19% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

On a final note, we've found 2 warning signs for Deswell Industries that we think you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.

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