Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. So, when we ran our eye over Federal Signal's (NYSE:FSS) trend of ROCE, we liked 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. Analysts use this formula to calculate it for Federal Signal:

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

0.16 = US$225m ÷ (US$1.6b - US$196m) (Based on the trailing twelve months to December 2023).

So, Federal Signal has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 13% it's much better.

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.

What The Trend Of ROCE Can Tell Us

While the returns on capital are good, they haven't moved much. The company has employed 65% more capital in the last five years, and the returns on that capital have remained stable at 16%. Since 16% 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.

The Bottom Line On Federal Signal's ROCE

To sum it up, Federal Signal has simply been reinvesting capital steadily, at those decent rates of return. And long term investors would be thrilled with the 228% return they've received over the last five years. 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.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.