Caterpillar (NYSE:CAT) Knows How To Allocate Capital Effectively

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at the ROCE trend of Caterpillar (NYSE:CAT) we really liked what we saw.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Caterpillar:

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

0.25 = US$14b ÷ (US$86b - US$32b) (Based on the trailing twelve months to September 2024).

Thus, Caterpillar has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.

See our latest analysis for Caterpillar

Above you can see how the current ROCE for Caterpillar 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 analyst report for Caterpillar .

What Does the ROCE Trend For Caterpillar Tell Us?

Caterpillar is showing promise given that its ROCE is trending up and to the right. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 59% over the last five years. 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. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

Our Take On Caterpillar's ROCE

As discussed above, Caterpillar appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And a remarkable 249% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Caterpillar does have some risks though, and we've spotted 2 warning signs for Caterpillar that you might be interested in.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.