What are the early trends we should look for to identify a stock that could 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That's why when we briefly looked at Ferguson's (NYSE:FERG) ROCE trend, we were very happy with what we saw.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Ferguson:

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

0.24 = US$2.6b ÷ (US$16b - US$5.5b) (Based on the trailing twelve months to April 2024).

Thus, Ferguson has an ROCE of 24%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.

In the above chart we have measured Ferguson'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 Ferguson .

How Are Returns Trending?

It's hard not to be impressed by Ferguson's returns on capital. Over the past five years, ROCE has remained relatively flat at around 24% and the business has deployed 52% more capital into its operations. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.

The Bottom Line

In short, we'd argue Ferguson has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. And long term investors would be thrilled with the 204% return they've received over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.

On a final note, we've found 2 warning signs for Ferguson that we think you should be aware of.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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.

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