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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. So, when we ran our eye over PACCAR's (NASDAQ:PCAR) trend of ROCE, we liked what we saw.
Return On Capital Employed (ROCE): What Is It?
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. The formula for this calculation on PACCAR is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = US$3.7b ÷ (US$33b - US$7.2b) (Based on the trailing twelve months to December 2022).
So, PACCAR has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 11% it's much better.
View our latest analysis for PACCAR
In the above chart we have measured PACCAR'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 PACCAR.
The Trend Of ROCE
The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has employed 53% more capital in the last five years, and the returns on that capital have remained stable at 14%. 14% is a pretty standard return, and it provides some comfort knowing that PACCAR has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
The Bottom Line On PACCAR's ROCE
In the end, PACCAR has proven its ability to adequately reinvest capital at good rates of return. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
PACCAR does have some risks, we noticed 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
While PACCAR may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.