Slowing Rates Of Return At Eaton (NYSE:ETN) Leave Little Room For Excitement

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Eaton (NYSE:ETN), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Eaton:

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

0.13 = US$3.9b ÷ (US$38b - US$7.7b) (Based on the trailing twelve months to December 2023).

Thus, Eaton has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Electrical industry average of 14%.

See our latest analysis for Eaton

In the above chart we have measured Eaton'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 Eaton here for free.

So How Is Eaton's ROCE Trending?

Things have been pretty stable at Eaton, with its capital employed and returns on that capital staying somewhat the same for the last five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So unless we see a substantial change at Eaton in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. This probably explains why Eaton is paying out 30% of its income to shareholders in the form of dividends. Unless businesses have highly compelling growth opportunities, they'll typically return some money to shareholders.

What We Can Learn From Eaton's ROCE

In a nutshell, Eaton has been trudging along with the same returns from the same amount of capital over the last five years. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 290% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing, we've spotted 1 warning sign facing Eaton that you might find interesting.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.