To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Stepan (NYSE:SCL) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Stepan is:

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

0.043 = US$73m ÷ (US$2.3b - US$655m) (Based on the trailing twelve months to June 2024).

Therefore, Stepan has an ROCE of 4.3%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 8.9%.

In the above chart we have measured Stepan's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Stepan .

How Are Returns Trending?

On the surface, the trend of ROCE at Stepan doesn't inspire confidence. To be more specific, ROCE has fallen from 11% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

What We Can Learn From Stepan's ROCE

We're a bit apprehensive about Stepan because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 13% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Stepan does have some risks though, and we've spotted 3 warning signs for Stepan that you might be interested in.

While Stepan 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.