Investors Shouldn't Overlook Watsco's (NYSE:WSO) Impressive 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? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, the ROCE of Watsco (NYSE:WSO) looks great, so lets see what the trend can tell us.

Understanding 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. To calculate this metric for Watsco, this is the formula:

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

0.30 = US$798m ÷ (US$3.6b - US$940m) (Based on the trailing twelve months to September 2022).

Therefore, Watsco has an ROCE of 30%. That's a fantastic return and not only that, it outpaces the average of 16% earned by companies in a similar industry.

See our latest analysis for Watsco

Above you can see how the current ROCE for Watsco compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Watsco.

What The Trend Of ROCE Can Tell Us

We like the trends that we're seeing from Watsco. Over the last five years, returns on capital employed have risen substantially to 30%. Basically the business is earning more per dollar of capital invested and in addition to that, 57% more capital is being employed now too. So we're very much inspired by what we're seeing at Watsco thanks to its ability to profitably reinvest capital.

What We Can Learn From Watsco's ROCE

In summary, it's great to see that Watsco can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with a respectable 86% 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. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

One final note, you should learn about the 2 warning signs we've spotted with Watsco (including 1 which doesn't sit too well with us) .

Watsco 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.