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Slowing Rates Of Return At A. O. Smith (NYSE:AOS) Leave Little Room For Excitement

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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. So when we looked at A. O. Smith (NYSE:AOS), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for A. O. Smith, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.25 = US$582m ÷ (US$3.3b - US$983m) (Based on the trailing twelve months to September 2021).

Thus, A. O. Smith has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Building industry average of 14%.

Check out our latest analysis for A. O. Smith

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Above you can see how the current ROCE for A. O. Smith 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 A. O. Smith here for free.

What Does the ROCE Trend For A. O. Smith Tell Us?

There hasn't been much to report for A. O. Smith's returns and its level of capital employed because both metrics have been steady for the past 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 it may not be a multi-bagger in the making, but given the decent 25% return on capital, it'd be difficult to find fault with the business's current operations.

The Bottom Line

While A. O. Smith has impressive profitability from its capital, it isn't increasing that amount of capital. Although the market must be expecting these trends to improve because the stock has gained 80% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

On a separate note, we've found 2 warning signs for A. O. Smith you'll probably want to know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.