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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So on that note, Federal Signal (NYSE:FSS) looks quite promising in regards to its trends of return on capital.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Federal Signal, this is the formula:

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

0.19 = US$283m ÷ (US$1.8b - US$242m) (Based on the trailing twelve months to December 2024).

So, Federal Signal has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 12% it's much better.

Check out our latest analysis for Federal Signal

Above you can see how the current ROCE for Federal Signal 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 Federal Signal for free.

What Does the ROCE Trend For Federal Signal Tell Us?

We like the trends that we're seeing from Federal Signal. Over the last five years, returns on capital employed have risen substantially to 19%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 52%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

The Bottom Line

All in all, it's terrific to see that Federal Signal is reaping the rewards from prior investments and is growing its capital base. And a remarkable 212% total return over the last five years tells us that investors are expecting more good things to come in the future. Therefore, we think it would be worth your time to check if these trends are going to continue.

On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation for FSS on our platform that is definitely worth checking out.

While Federal Signal 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.