Ferguson (NYSE:FERG) Might Become A Compounding Machine

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Ergo, when we looked at the ROCE trends at Ferguson (NYSE:FERG), we 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. The formula for this calculation on Ferguson is:

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

0.24 = US$2.6b ÷ (US$16b - US$4.8b) (Based on the trailing twelve months to January 2024).

Thus, Ferguson has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Trade Distributors industry average of 13%.

View our latest analysis for Ferguson

In the above chart we have measured Ferguson's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Ferguson .

What The Trend Of ROCE Can Tell Us

It's hard not to be impressed by Ferguson's returns on capital. The company has consistently earned 24% for the last five years, and the capital employed within the business has risen 53% in that time. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.

What We Can Learn From Ferguson's ROCE

In summary, we're delighted to see that Ferguson has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. On top of that, the stock has rewarded shareholders with a remarkable 239% return to those who've held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.

On a final note, we've found 1 warning sign for Ferguson that we think you should be aware of.

Ferguson 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.

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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.