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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. That's why when we briefly looked at Tetra Tech's (NASDAQ:TTEK) ROCE trend, we were pretty happy with what we saw.
Understanding Return On Capital Employed (ROCE)
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. Analysts use this formula to calculate it for Tetra Tech:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$420m ÷ (US$3.8b - US$1.2b) (Based on the trailing twelve months to October 2023).
Therefore, Tetra Tech has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 9.1% generated by the Commercial Services industry.
Check out our latest analysis for Tetra Tech
In the above chart we have measured Tetra Tech's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Tetra Tech here for free.
The Trend Of ROCE
While the current returns on capital are decent, they haven't changed much. The company has employed 95% more capital in the last five years, and the returns on that capital have remained stable at 16%. Since 16% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
The Bottom Line
To sum it up, Tetra Tech has simply been reinvesting capital steadily, at those decent rates of return. And the stock has done incredibly well with a 222% return over the last five years, so long term investors are no doubt ecstatic with that result. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
One more thing, we've spotted 2 warning signs facing Tetra Tech that you might find interesting.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.