There are a few key trends to look for if we want to identify the next multi-bagger. 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. Having said that, from a first glance at Deere (NYSE:DE) we aren’t jumping out of our chairs at how returns are trending, but let’s have a deeper look.
Return On Capital Employed (ROCE): What is it?
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 Deere, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.074 = US$4.0b ÷ (US$77b – US$24b) (Based on the trailing twelve months to August 2020).
Thus, Deere has an ROCE of 7.4%. In absolute terms, that’s a low return but it’s around the Machinery industry average of 9.3%.
View our latest analysis for Deere
Above you can see how the current ROCE for Deere compares to its prior returns on capital, but there’s only so much you can tell from the past. If you’d like to see what analysts are forecasting going forward, you should check out our free report for Deere.
The Trend Of ROCE
There are better returns on capital out there than what we’re seeing at Deere. The company has employed 42% more capital in the last five years, and the returns on that capital have remained stable at 7.4%. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don’t provide a high return on capital.
The Bottom Line
As we’ve seen above, Deere’s returns on capital haven’t increased but it is reinvesting in the business. Investors must think there’s better things to come because the stock has knocked it out of the park delivering a 241% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn’t get our hopes up too high.
Deere does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit unpleasant…
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.
This article by Simply Wall St is general in nature. 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.
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