If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, the ROCE of Kansas City Southern (NYSE:KSU) looks decent, right now, so lets see what the trend of returns can tell us.
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 Kansas City Southern, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$1.0b ÷ (US$10b - US$483m) (Based on the trailing twelve months to March 2021).
Therefore, Kansas City Southern has an ROCE of 10%. By itself that's a normal return on capital and it's in line with the industry's average returns of 9.9%.
Above you can see how the current ROCE for Kansas City Southern 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.
The Trend Of ROCE
While the current returns on capital are decent, they haven't changed much. Over the past five years, ROCE has remained relatively flat at around 10% and the business has deployed 27% more capital into its operations. 10% is a pretty standard return, and it provides some comfort knowing that Kansas City Southern has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
The main thing to remember is that Kansas City Southern has proven its ability to continually reinvest at respectable rates of return. And long term investors would be thrilled with the 182% return they've received over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
One more thing to note, we've identified 1 warning sign with Kansas City Southern and understanding it should be part of your investment process.
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.
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This article by Simply Wall St is general in nature. 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.
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