There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, while the ROCE is currently high for Illinois Tool Works (NYSE:ITW), we aren't jumping out of our chairs because returns are decreasing.
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 Illinois Tool Works is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.24 = US$2.9b ÷ (US$14b - US$2.0b) (Based on the trailing twelve months to June 2020).
So, Illinois Tool Works has an ROCE of 24%. That's a fantastic return and not only that, it outpaces the average of 9.2% earned by companies in a similar industry.
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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
There hasn't been much to report for Illinois Tool Works' returns and its level of capital employed because both metrics have been steady for the past five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So it may not be a multi-bagger in the making, but given the decent 24% return on capital, it'd be difficult to find fault with the business's current operations. That being the case, it makes sense that Illinois Tool Works has been paying out 61% of its earnings to its shareholders. These mature businesses typically have reliable earnings and not many places to reinvest them, so the next best option is to put the earnings into shareholders pockets.
The Key Takeaway
In summary, Illinois Tool Works isn't compounding its earnings but is generating decent returns on the same amount of capital employed. Yet to long term shareholders the stock has gifted them an incredible 157% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
If you want to continue researching Illinois Tool Works, you might be interested to know about the 1 warning sign that our analysis has discovered.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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