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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Although, when we looked at Eaton (NYSE:ETN), it didn't seem to tick all of these boxes.
What Is 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 Eaton, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = US$3.9b ÷ (US$38b - US$7.7b) (Based on the trailing twelve months to December 2023).
So, Eaton has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Electrical industry average of 14%.
View our latest analysis for Eaton
In the above chart we have measured Eaton's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Eaton .
What The Trend Of ROCE Can Tell Us
Over the past five years, Eaton's ROCE and capital employed have both remained mostly flat. 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. With that in mind, unless investment picks up again in the future, we wouldn't expect Eaton to be a multi-bagger going forward. With fewer investment opportunities, it makes sense that Eaton has been paying out a decent 33% of its earnings to shareholders. Unless businesses have highly compelling growth opportunities, they'll typically return some money to shareholders.
Our Take On Eaton's ROCE
We can conclude that in regards to Eaton's returns on capital employed and the trends, there isn't much change to report on. Yet to long term shareholders the stock has gifted them an incredible 308% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
If you want to continue researching Eaton, you might be interested to know about the 1 warning sign that our analysis has discovered.