What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Gorman-Rupp (NYSE:GRC) and its ROCE trend, we weren't exactly thrilled.
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. The formula for this calculation on Gorman-Rupp is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$37m ÷ (US$422m - US$55m) (Based on the trailing twelve months to September 2021).
Therefore, Gorman-Rupp has an ROCE of 10%. That's a pretty standard return and it's in line with the industry average of 10%.
In the above chart we have measured Gorman-Rupp'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 Gorman-Rupp here for free.
What Does the ROCE Trend For Gorman-Rupp Tell Us?
Over the past five years, Gorman-Rupp's ROCE and capital employed have both remained mostly flat. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect Gorman-Rupp to be a multi-bagger going forward.
What We Can Learn From Gorman-Rupp's ROCE
In summary, Gorman-Rupp isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Although the market must be expecting these trends to improve because the stock has gained 48% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
While Gorman-Rupp doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.
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.