Watsco (NYSE:WSO) Is Very Good At Capital Allocation

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. With that in mind, the ROCE of Watsco (NYSE:WSO) looks great, so lets see what the trend can tell us.

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. Analysts use this formula to calculate it for Watsco:

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

0.28 = US$769m ÷ (US$3.8b - US$1.1b) (Based on the trailing twelve months to June 2022).

So, Watsco has an ROCE of 28%. In absolute terms that's a great return and it's even better than the Trade Distributors industry average of 15%.

View 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 Can We Tell From Watsco's ROCE Trend?

Watsco is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 28%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 58%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

The Key Takeaway

To sum it up, Watsco has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Since the stock has returned a staggering 102% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Watsco can keep these trends up, it could have a bright future ahead.

One final note, you should learn about the 2 warning signs we've spotted with Watsco (including 1 which is concerning) .

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.