Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. So when we looked at ESAB (NYSE:ESAB) and its trend of ROCE, we really liked what we saw.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for ESAB, this is the formula:

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

0.14 = US$466m ÷ (US$4.1b - US$637m) (Based on the trailing twelve months to September 2024).

Therefore, ESAB has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 13% generated by the Machinery industry.

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

What The Trend Of ROCE Can Tell Us

ESAB's ROCE growth is quite impressive. More specifically, while the company has kept capital employed relatively flat over the last four years, the ROCE has climbed 68% in that same time. 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. 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.

The Bottom Line

To sum it up, ESAB is collecting higher returns from the same amount of capital, and that's impressive. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 65% return over the last year. 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.

On a separate note, we've found 1 warning sign for ESAB you'll probably want to know about.

While ESAB 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.