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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. With that in mind, the ROCE of Timken (NYSE:TKR) looks decent, right now, so lets see what the trend of returns can tell us.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Timken:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$517m ÷ (US$4.9b - US$740m) (Based on the trailing twelve months to September 2020).
Therefore, Timken has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 10% generated by the Machinery industry.
Above you can see how the current ROCE for Timken compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Timken here for free.
What The Trend Of ROCE Can Tell Us
While the current returns on capital are decent, they haven't changed much. The company has employed 78% more capital in the last five years, and the returns on that capital have remained stable at 12%. 12% is a pretty standard return, and it provides some comfort knowing that Timken has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
The Bottom Line
In the end, Timken has proven its ability to adequately reinvest capital at good rates of return. And long term investors would be thrilled with the 216% return they've received over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
On a final note, we've found 3 warning signs for Timken 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.
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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