To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. With that in mind, we've noticed some promising trends at ADT (NYSE:ADT) so let's look a bit deeper.

Understanding 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 ADT:

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

0.074 = US$1.1b ÷ (US$16b - US$1.3b) (Based on the trailing twelve months to June 2024).

Therefore, ADT has an ROCE of 7.4%. On its own, that's a low figure but it's around the 7.6% average generated by the Consumer Services industry.

In the above chart we have measured ADT'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 ADT for free.

What Does the ROCE Trend For ADT Tell Us?

ADT has not disappointed with their ROCE growth. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 184% in that same time. 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. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

In Conclusion...

As discussed above, ADT appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 35% to shareholders. So with that in mind, we think the stock deserves further research.

One final note, you should learn about the 4 warning signs we've spotted with ADT (including 1 which makes us a bit uncomfortable) .

While ADT may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.