If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. So when we looked at the ROCE trend of Watsco (NYSE:WSO) we really liked what we saw.

What Is 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. To calculate this metric for Watsco, this is the formula:

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

0.25 = US$783m ÷ (US$4.1b - US$956m) (Based on the trailing twelve months to June 2023).

Thus, Watsco has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Trade Distributors industry average of 14%.

View our latest analysis for Watsco

Above you can see how the current ROCE for Watsco compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Watsco here for free.

What The Trend Of ROCE Can Tell Us

We like the trends that we're seeing from Watsco. Over the last five years, returns on capital employed have risen substantially to 25%. The amount of capital employed has increased too, by 75%. So we're very much inspired by what we're seeing at Watsco thanks to its ability to profitably reinvest capital.

The Bottom Line

To sum it up, Watsco has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Watsco can keep these trends up, it could have a bright future ahead.

If you want to continue researching Watsco, you might be interested to know about the 2 warning signs that our analysis has discovered.

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.