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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Union Pacific (NYSE:UNP), 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 Union Pacific, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = US$7.7b ÷ (US$62b - US$4.9b) (Based on the trailing twelve months to March 2021).
So, Union Pacific has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 8.9% generated by the Transportation industry.
Above you can see how the current ROCE for Union Pacific 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 Union Pacific here for free.
So How Is Union Pacific's ROCE Trending?
Things have been pretty stable at Union Pacific, with its capital employed and returns on that capital staying somewhat the same for the last five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So don't be surprised if Union Pacific doesn't end up being a multi-bagger in a few years time. This probably explains why Union Pacific is paying out 38% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.
The Key Takeaway
In a nutshell, Union Pacific has been trudging along with the same returns from the same amount of capital over the last five years. Yet to long term shareholders the stock has gifted them an incredible 174% 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.
If you'd like to know about the risks facing Union Pacific, we've discovered 1 warning sign that you should be aware of.
While Union Pacific isn't earning the highest return, check out this free list of companies that are 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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