If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So, when we ran our eye over Federal Signal's (NYSE:FSS) trend of ROCE, we liked what we saw.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Federal Signal is:

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

0.18 = US$261m ÷ (US$1.7b - US$212m) (Based on the trailing twelve months to June 2024).

Thus, Federal Signal has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 14% generated by the Machinery industry.

See our latest analysis for Federal Signal

In the above chart we have measured Federal Signal's 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 Federal Signal for free.

How Are Returns Trending?

While the current returns on capital are decent, they haven't changed much. The company has employed 59% more capital in the last five years, and the returns on that capital have remained stable at 18%. 18% is a pretty standard return, and it provides some comfort knowing that Federal Signal has consistently earned this amount. 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 Key Takeaway

The main thing to remember is that Federal Signal has proven its ability to continually reinvest at respectable rates of return. And long term investors would be thrilled with the 195% return they've received over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

One more thing to note, we've identified 1 warning sign with Federal Signal and understanding this should be part of your investment process.

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.