If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Xylem (NYSE:XYL) and its ROCE trend, we weren't exactly thrilled.
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. The formula for this calculation on Xylem is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.088 = US$554m ÷ (US$8.2b - US$1.9b) (Based on the trailing twelve months to March 2022).
Therefore, Xylem has an ROCE of 8.8%. In absolute terms, that's a low return but it's around the Machinery industry average of 9.9%.
In the above chart we have measured Xylem's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Xylem here for free.
The Trend Of ROCE
Over the past five years, Xylem's ROCE and capital employed have both remained mostly flat. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So don't be surprised if Xylem doesn't end up being a multi-bagger in a few years time. This probably explains why Xylem is paying out 35% of its income to shareholders in the form of dividends. Unless businesses have highly compelling growth opportunities, they'll typically return some money to shareholders.
Our Take On Xylem's ROCE
We can conclude that in regards to Xylem's returns on capital employed and the trends, there isn't much change to report on. Although the market must be expecting these trends to improve because the stock has gained 46% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Xylem does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit unpleasant...
While Xylem may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.
Xylem Inc., together with its subsidiaries, engages in the design, manufacture, and servicing of engineered products and solutions for the water and wastewater applications in the United States, Europe, the Asia Pacific, and internationally.
Flawless balance sheet average dividend payer.