If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at the ROCE trend of A. O. Smith (NYSE:AOS) we really liked what we saw.

Return On Capital Employed (ROCE): What Is It?

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 A. O. Smith:

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

0.32 = US$746m ÷ (US$3.2b - US$883m) (Based on the trailing twelve months to March 2024).

So, A. O. Smith has an ROCE of 32%. That's a fantastic return and not only that, it outpaces the average of 17% 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're interested, you can view the analysts predictions in our free analyst report for A. O. Smith .

How Are Returns Trending?

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. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

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

To bring it all together, A. O. Smith has done well to increase the returns it's generating from its capital employed. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 94% return over the last five years. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.