Returns On Capital At Illinois Tool Works (NYSE:ITW) Have Stalled
To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at Illinois Tool Works (NYSE:ITW), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
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. Analysts use this formula to calculate it for Illinois Tool Works:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.37 = US$4.0b ÷ (US$16b - US$4.7b) (Based on the trailing twelve months to December 2023).
Therefore, Illinois Tool Works has an ROCE of 37%. In absolute terms that's a great return and it's even better than the Machinery industry average of 13%.
See our latest analysis for Illinois Tool Works
Above you can see how the current ROCE for Illinois Tool Works compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
Over the past five years, Illinois Tool Works' ROCE and capital employed have both remained mostly flat. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So it may not be a multi-bagger in the making, but given the decent 37% return on capital, it'd be difficult to find fault with the business's current operations. This probably explains why Illinois Tool Works is paying out 49% of its income to shareholders in the form of dividends. Unless businesses have highly compelling growth opportunities, they'll typically return some money to shareholders.
The Key Takeaway
Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. Yet to long term shareholders the stock has gifted them an incredible 105% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Illinois Tool Works does have some risks though, and we've spotted 1 warning sign for Illinois Tool Works that you might be interested in.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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.
