A. O. Smith (NYSE:AOS) Is Very Good At Capital Allocation

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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in A. O. Smith's (NYSE:AOS) returns on capital, so let's have a look.

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 A. O. Smith:

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

0.32 = US$750m ÷ (US$3.2b - US$872m) (Based on the trailing twelve months to June 2024).

So, A. O. Smith has an ROCE of 32%. That's a fantastic return and not only that, it outpaces the average of 16% earned by companies in a similar industry.

View our latest analysis for A. O. Smith

In the above chart we have measured A. O. Smith'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 A. O. Smith for free.

What Can We Tell From A. O. Smith's ROCE Trend?

A. O. Smith's ROCE growth is quite impressive. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 53% in that same time. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

The Bottom Line

To bring it all together, A. O. Smith has done well to increase the returns it's generating from its capital employed. Since the stock has returned a solid 96% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation for AOS on our platform that is definitely worth checking out.

A. O. Smith is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.