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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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. That's why when we briefly looked at Reece's (ASX:REH) ROCE trend, we were pretty happy with what we saw.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Reece is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = AU$674m ÷ (AU$7.1b - AU$1.5b) (Based on the trailing twelve months to June 2024).
So, Reece has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 11% generated by the Trade Distributors industry.
Check out our latest analysis for Reece
Above you can see how the current ROCE for Reece 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 Reece .
What The Trend Of ROCE Can Tell Us
While the current returns on capital are decent, they haven't changed much. The company has employed 53% more capital in the last five years, and the returns on that capital have remained stable at 12%. Since 12% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
The Bottom Line
The main thing to remember is that Reece has proven its ability to continually reinvest at respectable rates of return. On top of that, the stock has rewarded shareholders with a remarkable 115% return to those who've held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
One more thing, we've spotted 1 warning sign facing Reece that you might find interesting.
While Reece 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.