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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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Xylem (NYSE:XYL), we don't think it's current trends fit the mold of a multi-bagger.
Understanding Return On Capital Employed (ROCE)
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. To calculate this metric for Xylem, this is the formula:
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).
So, Xylem has an ROCE of 9.2%. On its own, that's a low figure but it's around the 10% average generated by the Machinery industry.
In the above chart we have measured Xylem's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Xylem Tell Us?
In terms of Xylem's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 12% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
The Bottom Line On Xylem's ROCE
In summary, Xylem is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 161% 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.
If you want to continue researching Xylem, you might be interested to know about the 2 warning signs that our analysis has discovered.
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.
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.
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