If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, while the ROCE is currently high for Graco (NYSE:GGG), we aren't jumping out of our chairs because returns are decreasing.
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. To calculate this metric for Graco, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.24 = US$581m ÷ (US$2.8b - US$352m) (Based on the trailing twelve months to March 2024).
Thus, Graco has an ROCE of 24%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.
Above you can see how the current ROCE for Graco compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Graco for free.
What Does the ROCE Trend For Graco Tell Us?
On the surface, the trend of ROCE at Graco doesn't inspire confidence. Historically returns on capital were even higher at 35%, but they have dropped over the last five years. However it looks like Graco might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
On a related note, Graco has decreased its current liabilities to 13% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
Our Take On Graco's ROCE
To conclude, we've found that Graco is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 82% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
If you're still interested in Graco it's worth checking out our FREE intrinsic value approximation for GGG to see if it's trading at an attractive price in other respects.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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.