Returns on Capital Paint A Bright Future For Caterpillar (NYSE:CAT)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. And in light of that, the trends we're seeing at Caterpillar's (NYSE:CAT) look very promising so lets take a look.

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. To calculate this metric for Caterpillar, this is the formula:

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

0.28 = US$14b ÷ (US$83b - US$34b) (Based on the trailing twelve months to June 2024).

Thus, Caterpillar has an ROCE of 28%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.

View our latest analysis for Caterpillar

In the above chart we have measured Caterpillar'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 Caterpillar for free.

What Can We Tell From Caterpillar's ROCE Trend?

Caterpillar's ROCE growth is quite impressive. 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 75% 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. 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.

Another thing to note, Caterpillar has a high ratio of current liabilities to total assets of 40%. 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 On Caterpillar's ROCE

To sum it up, Caterpillar is collecting higher returns from the same amount of capital, and that's impressive. And a remarkable 231% total return over the last five years tells us that investors are expecting more good things to come in the future. Therefore, we think it would be worth your time to check if these trends are going to continue.

If you'd like to know more about Caterpillar, we've spotted 3 warning signs, and 1 of them is concerning.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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.