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What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at TE Connectivity (NYSE:TEL), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
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. To calculate this metric for TE Connectivity, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = US$1.8b ÷ (US$20b - US$4.1b) (Based on the trailing twelve months to December 2020).
Therefore, TE Connectivity has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 12% generated by the Electronic industry.
In the above chart we have measured TE Connectivity'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 TE Connectivity here for free.
The Trend Of ROCE
Things have been pretty stable at TE Connectivity, with its capital employed and returns on that capital staying somewhat the same for the last five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So don't be surprised if TE Connectivity doesn't end up being a multi-bagger in a few years time.
Our Take On TE Connectivity's ROCE
In a nutshell, TE Connectivity has been trudging along with the same returns from the same amount of capital over the last five years. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 145% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Like most companies, TE Connectivity does come with some risks, and we've found 4 warning signs that 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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