There are a few key trends to look for if we want to identify the next multi-bagger. 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. That's why when we briefly looked at Armstrong World Industries' (NYSE:AWI) ROCE trend, we were pretty happy with what we saw.
What Is 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. The formula for this calculation on Armstrong World Industries is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = US$268m ÷ (US$1.8b - US$200m) (Based on the trailing twelve months to June 2024).
Thus, Armstrong World Industries has an ROCE of 17%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Building industry average of 16%.
In the above chart we have measured Armstrong World Industries' 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 analyst report for Armstrong World Industries .
So How Is Armstrong World Industries' ROCE Trending?
While the current returns on capital are decent, they haven't changed much. The company has employed 24% more capital in the last five years, and the returns on that capital have remained stable at 17%. Since 17% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. 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.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 11% of total assets, is good to see from a business owner's perspective. Effectively suppliers now fund less of the business, which can lower some elements of risk.
The Key Takeaway
In the end, Armstrong World Industries has proven its ability to adequately reinvest capital at good rates of return. In light of this, the stock has only gained 30% over the last five years for shareholders who have owned the stock in this period. So because of the trends we're seeing, we'd recommend looking further into this stock to see if it has the makings of a multi-bagger.
On a separate note, we've found 1 warning sign for Armstrong World Industries you'll probably want to know about.
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. 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.