If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at SFL (NYSE:SFL) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for SFL, this is the formula:

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

0.094 = US$315m ÷ (US$4.1b - US$747m) (Based on the trailing twelve months to September 2024).

So, SFL has an ROCE of 9.4%. On its own, that's a low figure but it's around the 12% average generated by the Oil and Gas industry.

Above you can see how the current ROCE for SFL 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 SFL for free.

The Trend Of ROCE

SFL is showing promise given that its ROCE is trending up and to the right. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 70% over the last five years. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. 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.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 18% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

What We Can Learn From SFL's ROCE

As discussed above, SFL appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Considering the stock has delivered 6.8% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

SFL does come with some risks though, we found 4 warning signs in our investment analysis, and 3 of those are concerning...

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.