If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, we've noticed some promising trends at Toll Brothers (NYSE:TOL) so let's look a bit deeper.
What Is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Toll Brothers:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = US$1.8b ÷ (US$13b - US$2.1b) (Based on the trailing twelve months to October 2023).
So, Toll Brothers has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Consumer Durables industry average of 14% it's much better.
Above you can see how the current ROCE for Toll Brothers 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 Toll Brothers for free.
The Trend Of ROCE
Toll Brothers' ROCE growth is quite impressive. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 85% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.
What We Can Learn From Toll Brothers' ROCE
In summary, we're delighted to see that Toll Brothers has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Since the stock has returned a staggering 204% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
If you'd like to know more about Toll Brothers, we've spotted 2 warning signs, and 1 of them is potentially serious.
While Toll Brothers may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.