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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. That's why when we briefly looked at Federal Signal's (NYSE:FSS) ROCE trend, we were pretty happy with what we saw.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Federal Signal, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.18 = US$261m ÷ (US$1.7b - US$212m) (Based on the trailing twelve months to June 2024).

So, Federal Signal has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 14% generated by the Machinery industry.

In the above chart we have measured Federal Signal's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Federal Signal for free.

How Are Returns Trending?

The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has consistently earned 18% for the last five years, and the capital employed within the business has risen 59% in that time. 18% is a pretty standard return, and it provides some comfort knowing that Federal Signal 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.

In Conclusion...

In the end, Federal Signal has proven its ability to adequately reinvest capital at good rates of return. And the stock has done incredibly well with a 229% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

If you're still interested in Federal Signal it's worth checking out our FREE intrinsic value approximation for FSS to see if it's trading at an attractive price in other respects.

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.