NVIDIA's (NASDAQ:NVDA) Returns On Capital Not Reflecting Well On The Business

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. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at NVIDIA (NASDAQ:NVDA) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on NVIDIA is:

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

0.16 = US$5.6b ÷ (US$41b - US$6.6b) (Based on the trailing twelve months to January 2023).

So, NVIDIA has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Semiconductor industry average of 13% it's much better.

See our latest analysis for NVIDIA

In the above chart we have measured NVIDIA'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 NVIDIA here for free.

What Can We Tell From NVIDIA's ROCE Trend?

On the surface, the trend of ROCE at NVIDIA doesn't inspire confidence. Around five years ago the returns on capital were 32%, but since then they've fallen to 16%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Our Take On NVIDIA's ROCE

Bringing it all together, while we're somewhat encouraged by NVIDIA's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 365% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

If you'd like to know about the risks facing NVIDIA, we've discovered 3 warning signs that you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

What are the risks and opportunities for NVIDIA?

NasdaqGS:NVDA

NVIDIA

NVIDIA Corporation provides graphics, and compute and networking solutions in the United States, Taiwan, China, and internationally.Show more

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Rewards

• Earnings are forecast to grow 30.99% per year

• Earnings grew by 33.1% over the past year

Risks

• Significant insider selling over the past 3 months

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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.