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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? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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 briefly looking over the numbers, we don't think PPG Industries (NYSE:PPG) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. Analysts use this formula to calculate it for PPG Industries:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$2.0b ÷ (US$22b - US$5.5b) (Based on the trailing twelve months to June 2021).
So, PPG Industries has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 9.8% generated by the Chemicals industry.
Above you can see how the current ROCE for PPG Industries compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering PPG Industries here for free.
What Does the ROCE Trend For PPG Industries Tell Us?
On the surface, the trend of ROCE at PPG Industries doesn't inspire confidence. Over the last five years, returns on capital have decreased to 12% from 16% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that PPG Industries is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 56% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
One more thing, we've spotted 1 warning sign facing PPG Industries that you might find interesting.
While PPG Industries isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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