To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Speaking of which, we noticed some great changes in Illinois Tool Works' (NYSE:ITW) returns on capital, so let's have a look.

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. Analysts use this formula to calculate it for Illinois Tool Works:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.40 = US$4.3b ÷ (US$16b - US$4.8b) (Based on the trailing twelve months to June 2024).

Therefore, Illinois Tool Works has an ROCE of 40%. In absolute terms that's a great return and it's even better than the Machinery industry average of 13%.

Check out our latest analysis for Illinois Tool Works

Above you can see how the current ROCE for Illinois Tool Works 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 analyst report for Illinois Tool Works .

How Are Returns Trending?

Illinois Tool Works is showing promise given that its ROCE is trending up and to the right. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 48% in that same time. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 31% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

In Conclusion...

In summary, we're delighted to see that Illinois Tool Works has been able to increase efficiencies and earn higher rates of return on the same amount of capital. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 73% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Illinois Tool Works does have some risks though, and we've spotted 1 warning sign for Illinois Tool Works that you might be interested in.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.