Investors Will Want NOW's (NYSE:DNOW) Growth In ROCE To Persist

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in NOW's (NYSE:DNOW) returns on capital, so let's have a look.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on NOW is:

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

0.029 = US$21m ÷ (US$1.1b - US$375m) (Based on the trailing twelve months to September 2021).

Thus, NOW has an ROCE of 2.9%. Ultimately, that's a low return and it under-performs the Trade Distributors industry average of 12%.

Check out our latest analysis for NOW

Above you can see how the current ROCE for NOW 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 report on analyst forecasts for the company.

What Can We Tell From NOW's ROCE Trend?

Like most people, we're pleased that NOW is now generating some pretax earnings. Historically the company was generating losses but as we can see from the latest figures referenced above, they're now earning 2.9% on their capital employed. At first glance, it seems the business is getting more proficient at generating returns, because over the same period, the amount of capital employed has reduced by 49%. NOW could be selling under-performing assets since the ROCE is improving.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 34% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line On NOW's ROCE

In the end, NOW has proven it's capital allocation skills are good with those higher returns from less amount of capital. Astute investors may have an opportunity here because the stock has declined 50% in the last five years. So researching this company further and determining whether or not these trends will continue seems justified.

On a separate note, we've found 1 warning sign for NOW you'll probably want to know about.

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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.