What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 ADT (NYSE:ADT) and its trend of ROCE, we really liked what we saw.
Return On Capital Employed (ROCE): What Is It?
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. Analysts use this formula to calculate it for ADT:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = US$1.1b ÷ (US$17b - US$2.3b) (Based on the trailing twelve months to September 2023).
Thus, ADT has an ROCE of 7.0%. In absolute terms, that's a low return but it's around the Consumer Services industry average of 7.6%.
Above you can see how the current ROCE for ADT 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 ADT .
What The Trend Of ROCE Can Tell Us
ADT is showing promise given that its ROCE is trending up and to the right. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 183% in that same time. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. 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.
Our Take On ADT's ROCE
In summary, we're delighted to see that ADT has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Since the total return from the stock has been almost flat over the last five years, there might be an opportunity here if the valuation looks good. With that in mind, we believe the promising trends warrant this stock for further investigation.
One final note, you should learn about the 3 warning signs we've spotted with ADT (including 1 which is concerning) .
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.
