To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Watts Water Technologies (NYSE:WTS) and its trend of ROCE, 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 Watts Water Technologies:

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

0.19 = US$356m ÷ (US$2.3b - US$406m) (Based on the trailing twelve months to December 2023).

Thus, Watts Water Technologies has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 13% generated by the Machinery industry.

Above you can see how the current ROCE for Watts Water Technologies 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 Watts Water Technologies .

What The Trend Of ROCE Can Tell Us

We like the trends that we're seeing from Watts Water Technologies. Over the last five years, returns on capital employed have risen substantially to 19%. The amount of capital employed has increased too, by 46%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

The Bottom Line On Watts Water Technologies' ROCE

All in all, it's terrific to see that Watts Water Technologies is reaping the rewards from prior investments and is growing its capital base. And a remarkable 169% total return over the last five years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

If you want to continue researching Watts Water Technologies, you might be interested to know about the 1 warning sign that our analysis has discovered.

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.