Investors Should Be Encouraged By Illinois Tool Works' (NYSE:ITW) Returns On Capital

What are the early trends we should look for to identify a stock that could 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at the ROCE trend of Illinois Tool Works (NYSE:ITW) we really liked what we saw.

Understanding 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. The formula for this calculation on Illinois Tool Works is:

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

0.35 = US$3.8b ÷ (US$15b - US$4.5b) (Based on the trailing twelve months to December 2022).

Thus, Illinois Tool Works has an ROCE of 35%. In absolute terms that's a great return and it's even better than the Machinery industry average of 12%.

Check out our latest analysis for Illinois Tool Works

In the above chart we have measured Illinois Tool Works' 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 Illinois Tool Works here for free.

SWOT Analysis for Illinois Tool Works

So How Is Illinois Tool Works' ROCE Trending?

We're pretty happy with how the ROCE has been trending at Illinois Tool Works. The figures show that over the last five years, returns on capital have grown by 41%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Speaking of capital employed, the company is actually utilizing 20% less than it was five years ago, which can be indicative of a business that's improving its efficiency. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 29% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

Our Take On Illinois Tool Works' ROCE

In a nutshell, we're pleased to see that Illinois Tool Works has been able to generate higher returns from less capital. And with a respectable 66% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Like most companies, Illinois Tool Works does come with some risks, and we've found 1 warning sign that you should be aware of.

Illinois Tool Works 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.

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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.