A. O. Smith (NYSE:AOS) Knows How To Allocate Capital Effectively

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at the ROCE trend of A. O. Smith (NYSE:AOS) we really liked what we saw.

Understanding 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 A. O. Smith is:

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

0.29 = US$700m ÷ (US$3.2b - US$861m) (Based on the trailing twelve months to June 2023).

So, A. O. Smith has an ROCE of 29%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.

Check out 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

A. O. Smith has not disappointed with their ROCE growth. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 22% in that same time. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. 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.

What We Can Learn From A. O. Smith's ROCE

In summary, we're delighted to see that A. O. Smith has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Considering the stock has delivered 37% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

One more thing to note, we've identified 2 warning signs with A. O. Smith and understanding these should be part of your investment process.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.