There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it’s a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Eaton (NYSE:ETN) we aren’t jumping out of our chairs at how returns are trending, but let’s have a deeper look.
What Is Return On Capital Employed (ROCE)?
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Eaton is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.10 = US$2.6b ÷ (US$35b – US$9.0b) (Based on the trailing twelve months to June 2022).
Therefore, Eaton has an ROCE of 10%. In absolute terms, that’s a satisfactory return, but compared to the Electrical industry average of 8.0% it’s much better.
View our latest analysis for Eaton
In the above chart we have measured Eaton’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 Eaton.
How Are Returns Trending?
There hasn’t been much to report for Eaton’s returns and its level of capital employed because both metrics have been steady for the past five years. It’s not uncommon to see this when looking at a mature and stable business that isn’t re-investing its earnings because it has likely passed that phase of the business cycle. With that in mind, unless investment picks up again in the future, we wouldn’t expect Eaton to be a multi-bagger going forward. With fewer investment opportunities, it makes sense that Eaton has been paying out a decent 41% of its earnings to shareholders. Given the business isn’t reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.
The Bottom Line On Eaton’s ROCE
In a nutshell, Eaton has been trudging along with the same returns from the same amount of capital over the last five years. Investors must think there’s better things to come because the stock has knocked it out of the park, delivering a 115% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn’t hold our breath on it being a multi-bagger going forward.
On a final note, we found 4 warning signs for Eaton (1 makes us a bit uncomfortable) you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.
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