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If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Speaking of which, we noticed some great changes in Caterpillar's (NYSE:CAT) returns on capital, so let's have a look.
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. The formula for this calculation on Caterpillar is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$5.5b ÷ (US$81b - US$27b) (Based on the trailing twelve months to March 2021).
Thus, Caterpillar has an ROCE of 10%. By itself that's a normal return on capital and it's in line with the industry's average returns of 9.7%.
Above you can see how the current ROCE for Caterpillar 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.
What The Trend Of ROCE Can Tell Us
Caterpillar has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 50% whilst employing roughly the same amount of capital. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
The Bottom Line
To sum it up, Caterpillar is collecting higher returns from the same amount of capital, and that's impressive. Since the stock has returned a staggering 286% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Caterpillar can keep these trends up, it could have a bright future ahead.
Caterpillar does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is concerning...
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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