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If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So on that note, Watts Water Technologies (NYSE:WTS) looks quite promising in regards to its trends of return on capital.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Watts Water Technologies:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = US$187m ÷ (US$1.7b - US$295m) (Based on the trailing twelve months to September 2020).
So, Watts Water Technologies has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 10% generated by the Machinery industry.
In the above chart we have measured Watts Water Technologies' 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 Watts Water Technologies here for free.
What Does the ROCE Trend For Watts Water Technologies Tell Us?
Watts Water Technologies has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 133% over the last five years. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
One more thing to note, Watts Water Technologies has decreased current liabilities to 17% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
The Bottom Line On Watts Water Technologies' ROCE
To sum it up, Watts Water Technologies is collecting higher returns from the same amount of capital, and that's impressive. Since the stock has returned a staggering 187% to shareholders over the last five years, it looks like investors are recognizing these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
One more thing, we've spotted 1 warning sign facing Watts Water Technologies that you might find interesting.
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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