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. So when we looked at the ROCE trend of A. O. Smith (NYSE:AOS) we really liked 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. To calculate this metric for A. O. Smith, this is the formula:

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

0.32 = US$750m ÷ (US$3.2b - US$872m) (Based on the trailing twelve months to June 2024).

So, A. O. Smith has an ROCE of 32%. That's a fantastic return and not only that, it outpaces the average of 16% earned by companies in a similar industry.

In the above chart we have measured A. O. Smith'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 analyst report for A. O. Smith .

How Are Returns Trending?

A. O. Smith has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 53% whilst employing roughly the same amount of capital. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. 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.

What We Can Learn From A. O. Smith's ROCE

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. And with a respectable 92% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. In light of that, we think it's worth looking further into this stock because if A. O. Smith can keep these trends up, it could have a bright future ahead.

While A. O. Smith looks impressive, no company is worth an infinite price. The intrinsic value infographic for AOS helps visualize whether it is currently trading for a fair price.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.