If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, we've noticed some promising trends at Federal Signal (NYSE:FSS) so let's look a bit deeper.

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. To calculate this metric for Federal Signal, this is the formula:

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

0.18 = US$274m ÷ (US$1.7b - US$229m) (Based on the trailing twelve months to September 2024).

Therefore, Federal Signal has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 13% generated by the Machinery industry.

Above you can see how the current ROCE for Federal Signal 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 Federal Signal .

What Does the ROCE Trend For Federal Signal Tell Us?

The trends we've noticed at Federal Signal are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 18%. Basically the business is earning more per dollar of capital invested and in addition to that, 49% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

The Key Takeaway

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Federal Signal has. 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 Federal Signal can keep these trends up, it could have a bright future ahead.

Federal Signal does have some risks though, and we've spotted 1 warning sign for Federal Signal that you might be interested in.

While Federal Signal 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.