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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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Republic Services (NYSE:RSG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is Return On Capital Employed (ROCE)?
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 Republic Services, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.094 = US$2.1b ÷ (US$24b - US$2.3b) (Based on the trailing twelve months to September 2021).
So, Republic Services has an ROCE of 9.4%. Even though it's in line with the industry average of 8.9%, it's still a low return by itself.
See our latest analysis for Republic Services
In the above chart we have measured Republic Services' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Republic Services here for free.
So How Is Republic Services' ROCE Trending?
Over the past five years, Republic Services' ROCE and capital employed have both remained mostly flat. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So don't be surprised if Republic Services doesn't end up being a multi-bagger in a few years time. This probably explains why Republic Services is paying out 39% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.
Our Take On Republic Services' ROCE
In summary, Republic Services isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 172% 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.