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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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. That's why when we briefly looked at Landstar System's (NASDAQ:LSTR) ROCE trend, we were very happy with what we saw.
Understanding Return On Capital Employed (ROCE)
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. Analysts use this formula to calculate it for Landstar System:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.32 = US$268m ÷ (US$1.7b - US$806m) (Based on the trailing twelve months to December 2020).
Thus, Landstar System has an ROCE of 32%. That's a fantastic return and not only that, it outpaces the average of 9.9% earned by companies in a similar industry.
In the above chart we have measured Landstar System'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 Landstar System here for free.
How Are Returns Trending?
It's hard not to be impressed by Landstar System's returns on capital. Over the past five years, ROCE has remained relatively flat at around 32% and the business has deployed 36% more capital into its operations. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 49% of total assets, this reported ROCE would probably be less than32% because total capital employed would be higher.The 32% ROCE could be even lower if current liabilities weren't 49% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.
In short, we'd argue Landstar System has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. On top of that, the stock has rewarded shareholders with a remarkable 186% return to those who've held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
Landstar System does have some risks though, and we've spotted 1 warning sign for Landstar System that you might be interested in.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. 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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