Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. However, after investigating Packaging Corporation of America (NYSE:PKG), we don't think it's current trends fit the mold of a multi-bagger.
Understanding 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 Packaging Corporation of America, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = US$875m ÷ (US$7.4b - US$775m) (Based on the trailing twelve months to September 2020).
Thus, Packaging Corporation of America has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Packaging industry average of 10% it's much better.
In the above chart we have measured Packaging Corporation of America's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Packaging Corporation of America.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Packaging Corporation of America doesn't inspire confidence. Over the last five years, returns on capital have decreased to 13% from 17% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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 On Packaging Corporation of America's ROCE
To conclude, we've found that Packaging Corporation of America 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 192% 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.
On a separate note, we've found 3 warning signs for Packaging Corporation of America you'll probably want to know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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