Stock Analysis

Why You Should Care About Graco's (NYSE:GGG) Strong Returns On Capital

NYSE:GGG
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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. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. That's why when we briefly looked at Graco's (NYSE:GGG) ROCE trend, we were very happy with what we saw.

Return On Capital Employed (ROCE): What Is It?

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 Graco is:

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

0.28 = US$601m ÷ (US$2.5b - US$382m) (Based on the trailing twelve months to March 2023).

So, Graco has an ROCE of 28%. In absolute terms that's a great return and it's even better than the Machinery industry average of 11%.

View our latest analysis for Graco

roce
NYSE:GGG Return on Capital Employed May 21st 2023

In the above chart we have measured Graco's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Graco.

SWOT Analysis for Graco

Strength
  • Earnings growth over the past year exceeded its 5-year average.
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Earnings growth over the past year underperformed the Machinery industry.
  • Dividend is low compared to the top 25% of dividend payers in the Machinery market.
  • Expensive based on P/E ratio and estimated fair value.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
Threat
  • Annual earnings are forecast to grow slower than the American market.

What Does the ROCE Trend For Graco Tell Us?

In terms of Graco's history of ROCE, it's quite impressive. Over the past five years, ROCE has remained relatively flat at around 28% and the business has deployed 79% more capital into its operations. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

In Conclusion...

In short, we'd argue Graco has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. Therefore it's no surprise that shareholders have earned a respectable 81% return if they held over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

On a final note, we've found 1 warning sign for Graco that we think you should be aware of.

Graco is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

Valuation is complex, but we're helping make it simple.

Find out whether Graco is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.