Returns At Watts (TSE:2735) Appear To Be Weighed Down

There are a few key trends to look for if we want to identify the next multi-bagger. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Watts (TSE:2735), we don't think it's current trends fit the mold of a multi-bagger.

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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. Analysts use this formula to calculate it for Watts:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.081 = JP¥1.3b ÷ (JP¥31b - JP¥14b) (Based on the trailing twelve months to November 2024).

So, Watts has an ROCE of 8.1%. In absolute terms, that's a low return but it's around the Multiline Retail industry average of 9.0%.

See our latest analysis for Watts

Historical performance is a great place to start when researching a stock so above you can see the gauge for Watts' ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Watts .

What Can We Tell From Watts' ROCE Trend?

There are better returns on capital out there than what we're seeing at Watts. The company has employed 43% more capital in the last five years, and the returns on that capital have remained stable at 8.1%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

On a side note, Watts' current liabilities are still rather high at 47% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

In summary, Watts has simply been reinvesting capital and generating the same low rate of return as before. Unsurprisingly, the stock has only gained 13% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

On a final note, we found 3 warning signs for Watts (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.