Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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 when we looked at MSC Industrial Direct (NYSE:MSM), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
Return On Capital Employed (ROCE): What Is It?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on MSC Industrial Direct is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.26 = US$492m ÷ (US$2.5b - US$649m) (Based on the trailing twelve months to September 2023).
So, MSC Industrial Direct has an ROCE of 26%. 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 MSC Industrial Direct
In the above chart we have measured MSC Industrial Direct'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 MSC Industrial Direct.
The Trend Of ROCE
Over the past five years, MSC Industrial Direct's ROCE and capital employed have both remained mostly flat. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So it may not be a multi-bagger in the making, but given the decent 26% return on capital, it'd be difficult to find fault with the business's current operations. With fewer investment opportunities, it makes sense that MSC Industrial Direct has been paying out a decent 51% of its earnings to shareholders. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.
In Conclusion...
Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. Although the market must be expecting these trends to improve because the stock has gained 54% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
One more thing to note, we've identified 2 warning signs with MSC Industrial Direct and understanding these should be part of your investment process.
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.
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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.