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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Union Pacific (NYSE:UNP), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
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. Analysts use this formula to calculate it for Union Pacific:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$9.7b ÷ (US$66b - US$6.2b) (Based on the trailing twelve months to March 2023).
Thus, Union Pacific has an ROCE of 16%. That's a relatively normal return on capital, and it's around the 14% generated by the Transportation industry.
Check out our latest analysis for Union Pacific
Above you can see how the current ROCE for Union Pacific 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 Union Pacific here for free.
The Trend Of ROCE
There hasn't been much to report for Union Pacific's returns and its level of capital employed because both metrics have been steady for the past five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So unless we see a substantial change at Union Pacific in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. With fewer investment opportunities, it makes sense that Union Pacific has been paying out a decent 44% of its earnings to shareholders. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.
The Bottom Line
In summary, Union Pacific isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Since the stock has gained an impressive 60% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.