If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. That's why when we briefly looked at Donaldson Company's (NYSE:DCI) ROCE trend, we were very happy with what we saw.

Understanding 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. To calculate this metric for Donaldson Company, this is the formula:

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

0.26 = US$549m ÷ (US$2.9b - US$783m) (Based on the trailing twelve months to July 2024).

Therefore, Donaldson Company has an ROCE of 26%. In absolute terms that's a great return and it's even better than the Machinery industry average of 13%.

Above you can see how the current ROCE for Donaldson Company 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 Donaldson Company for free.

What Can We Tell From Donaldson Company's ROCE Trend?

It's hard not to be impressed by Donaldson Company's returns on capital. Over the past five years, ROCE has remained relatively flat at around 26% and the business has deployed 28% 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 Key Takeaway

In short, we'd argue Donaldson Company has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

One more thing to note, we've identified 1 warning sign with Donaldson Company and understanding this should be part of your investment process.

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.