If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. And in light of that, the trends we're seeing at Ferguson's (NYSE:FERG) look very promising so lets take a look.

Return On Capital Employed (ROCE): What Is It?

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 Ferguson, this is the formula:

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

0.28 = US$2.9b ÷ (US$16b - US$5.1b) (Based on the trailing twelve months to October 2022).

Therefore, Ferguson has an ROCE of 28%. In absolute terms that's a great return and it's even better than the Trade Distributors industry average of 16%.

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 report for Ferguson.

How Are Returns Trending?

Ferguson is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 28%. The amount of capital employed has increased too, by 59%. So we're very much inspired by what we're seeing at Ferguson thanks to its ability to profitably reinvest capital.

One more thing to note, Ferguson has decreased current liabilities to 33% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

Our Take On Ferguson's ROCE

In summary, it's great to see that Ferguson can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. 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.

If you'd like to know about the risks facing Ferguson, we've discovered 3 warning signs that you should be aware of.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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.

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