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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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. So, when we ran our eye over Amphenol's (NYSE:APH) trend of ROCE, we liked what we saw.
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. The formula for this calculation on Amphenol is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = US$1.6b ÷ (US$12b - US$2.2b) (Based on the trailing twelve months to September 2020).
So, Amphenol has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 10% it's much better.
In the above chart we have measured Amphenol'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 Amphenol here for free.
The Trend Of ROCE
The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has employed 49% more capital in the last five years, and the returns on that capital have remained stable at 17%. Since 17% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. 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 On Amphenol's ROCE
To sum it up, Amphenol has simply been reinvesting capital steadily, at those decent rates of return. And the stock has done incredibly well with a 143% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
One more thing to note, we've identified 2 warning signs with Amphenol and understanding these should be part of your investment process.
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.
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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