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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? 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. 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 Timken's (NYSE:TKR) trend of ROCE, we liked what we saw.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Timken:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$519m ÷ (US$5.1b - US$917m) (Based on the trailing twelve months to March 2021).
Therefore, Timken has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 9.4% it's much better.
In the above chart we have measured Timken'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 Timken here for free.
What The Trend Of ROCE Can Tell Us
The trend of ROCE doesn't stand out much, but returns on a whole are decent. Over the past five years, ROCE has remained relatively flat at around 12% and the business has deployed 74% more capital into its operations. Since 12% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
What We Can Learn From Timken's ROCE
To sum it up, Timken has simply been reinvesting capital steadily, at those decent rates of return. And long term investors would be thrilled with the 196% return they've received over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
If you want to continue researching Timken, you might be interested to know about the 2 warning signs that our analysis has discovered.
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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