Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Although, when we looked at Xylem (NYSE:XYL), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Xylem:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.092 = US$628m ÷ (US$8.2b - US$1.3b) (Based on the trailing twelve months to September 2021).
Therefore, Xylem has an ROCE of 9.2%. In absolute terms, that's a low return but it's around the Machinery industry average of 10%.
Above you can see how the current ROCE for Xylem 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 Xylem.
How Are Returns Trending?
When we looked at the ROCE trend at Xylem, we didn't gain much confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 9.2%. However it looks like Xylem might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line
To conclude, we've found that Xylem is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 160% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing, we've spotted 1 warning sign facing Xylem that you might find interesting.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
What are the risks and opportunities for Xylem?
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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.
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