There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. That's why when we briefly looked at Timken's (NYSE:TKR) ROCE trend, we were pretty happy with what we saw.
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. The formula for this calculation on Timken is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = US$676m ÷ (US$6.5b - US$1.4b) (Based on the trailing twelve months to March 2024).
Thus, Timken has an ROCE of 13%. That's a relatively normal return on capital, and it's around the 12% generated by the Machinery industry.
In the above chart we have measured Timken'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 Timken for free.
How Are Returns Trending?
While the current returns on capital are decent, they haven't changed much. Over the past five years, ROCE has remained relatively flat at around 13% and the business has deployed 28% more capital into its operations. 13% is a pretty standard return, and it provides some comfort knowing that Timken has consistently earned this amount. 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
In the end, Timken has proven its ability to adequately reinvest capital at good rates of return. And the stock has done incredibly well with a 106% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
One more thing to note, we've identified 2 warning signs with Timken and understanding these should be part of your investment process.
While Timken isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.