Watsco (NYSE:WSO) Might Become A Compounding Machine

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. With that in mind, the ROCE of Watsco (NYSE:WSO) looks attractive right now, so lets see what the trend of returns can tell us.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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)

0.25 = US$801m ÷ (US$4.0b - US$888m) (Based on the trailing twelve months to September 2023).

So, Watsco has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.

Check out 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Watsco's ROCE Trend?

Watsco deserves to be commended in regards to it's returns. Over the past five years, ROCE has remained relatively flat at around 25% and the business has deployed 83% more capital into its operations. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.

The Bottom Line

Watsco has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. On top of that, the stock has rewarded shareholders with a remarkable 201% return to those who've held over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

One more thing, we've spotted 1 warning sign facing Watsco that you might find interesting.

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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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.