If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. And in light of that, the trends we're seeing at A. O. Smith's (NYSE:AOS) look very promising so lets take a look.

What Is 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. Analysts use this formula to calculate it for A. O. Smith:

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

0.32 = US$729m ÷ (US$3.2b - US$844m) (Based on the trailing twelve months to September 2024).

So, A. O. Smith has an ROCE of 32%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.

Above you can see how the current ROCE for A. O. Smith compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for A. O. Smith .

The Trend Of ROCE

A. O. Smith is showing promise given that its ROCE is trending up and to the right. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 48% over the last five years. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

The Bottom Line

As discussed above, A. O. Smith appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has returned a solid 73% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation for AOS that compares the share price and estimated value.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.