What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So, when we ran our eye over Canadian National Railway’s (TSE:CNR) trend of ROCE, we liked what we saw.
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. The formula for this calculation on Canadian National Railway is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.14 = CA$5.7b ÷ (CA$45b – CA$3.4b) (Based on the trailing twelve months to June 2020).
Therefore, Canadian National Railway has an ROCE of 14%. In absolute terms, that’s a pretty normal return, and it’s somewhat close to the Transportation industry average of 12%.
Above you can see how the current ROCE for Canadian National Railway compares to its prior returns on capital, but there’s only so much you can tell from the past. If you’re interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Canadian National Railway Tell Us?
While the returns on capital are good, they haven’t moved much. The company has employed 37% more capital in the last five years, and the returns on that capital have remained stable at 14%. 14% is a pretty standard return, and it provides some comfort knowing that Canadian National Railway has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
Our Take On Canadian National Railway’s ROCE
In the end, Canadian National Railway has proven its ability to adequately reinvest capital at good rates of return. On top of that, the stock has rewarded shareholders with a remarkable 107% return to those who’ve held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
On a separate note, we’ve found 1 warning sign for Canadian National Railway you’ll probably want to know about.
While Canadian National Railway 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. 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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