If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. That's why when we briefly looked at Resideo Technologies' (NYSE:REZI) ROCE trend, we were pretty happy with what we saw.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Resideo Technologies, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = US$588m ÷ (US$5.7b - US$1.5b) (Based on the trailing twelve months to July 2021).
So, Resideo Technologies has an ROCE of 14%. That's a pretty standard return and it's in line with the industry average of 14%.
In the above chart we have measured Resideo Technologies' 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.
What Does the ROCE Trend For Resideo Technologies Tell Us?
While the returns on capital are good, they haven't moved much. The company has consistently earned 14% for the last four years, and the capital employed within the business has risen 28% in that time. 14% is a pretty standard return, and it provides some comfort knowing that Resideo Technologies has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
The Bottom Line
To sum it up, Resideo Technologies has simply been reinvesting capital steadily, at those decent rates of return. In light of this, the stock has only gained 7.3% over the last three years for shareholders who have owned the stock in this period. So because of the trends we're seeing, we'd recommend looking further into this stock to see if it has the makings of a multi-bagger.
One more thing, we've spotted 4 warning signs facing Resideo Technologies that you might find interesting.
While Resideo Technologies isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
What are the risks and opportunities for Resideo Technologies?
Trading at 41% below our estimate of its fair value
Earnings are forecast to grow 11.03% per year
Earnings have grown 45% per year over the past 5 years
Debt is not well covered by operating cash flow
Large one-off items impacting financial results
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.
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Resideo Technologies, Inc. develops, manufactures, and sells comfort, residential thermal, and security solutions to the commercial and residential end markets in the United States, Europe, and internationally.
Very undervalued with mediocre balance sheet.