If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So on that note, TransDigm Group (NYSE:TDG) looks quite promising in regards to its trends of return on capital.

Understanding 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 TransDigm Group, this is the formula:

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

0.19 = US$3.6b ÷ (US$26b - US$6.3b) (Based on the trailing twelve months to September 2024).

So, TransDigm Group has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Aerospace & Defense industry average of 9.6% it's much better.

See our latest analysis for TransDigm Group

Above you can see how the current ROCE for TransDigm Group 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 TransDigm Group for free.

What Does the ROCE Trend For TransDigm Group Tell Us?

TransDigm Group is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years 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 31%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 25% of its operations, which isn't ideal. 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, it's great to see that TransDigm Group can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And a remarkable 149% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

If you want to know some of the risks facing TransDigm Group we've found 3 warning signs (2 are a bit unpleasant!) that you should be aware of before investing here.

While TransDigm Group 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.