What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at the ROCE trend of Watts Water Technologies (NYSE:WTS) we really liked what we saw.
What Is 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. 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)
0.21 = US$316m ÷ (US$1.9b - US$379m) (Based on the trailing twelve months to September 2022).
Thus, Watts Water Technologies has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Machinery industry average of 11%.
Above you can see how the current ROCE for Watts Water Technologies compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Watts Water Technologies.
What Does the ROCE Trend For Watts Water Technologies Tell Us?
Watts Water Technologies has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 87% 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. 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.
The Key Takeaway
As discussed above, Watts Water Technologies appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has returned a staggering 119% 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 Watts Water Technologies can keep these trends up, it could have a bright future ahead.
One more thing to note, we've identified 1 warning sign with Watts Water Technologies and understanding this should be part of your investment process.
Watts Water Technologies is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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.
Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here