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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Although, when we looked at Kratos Defense & Security Solutions (NASDAQ:KTOS), it didn't seem to tick all of these boxes.

We've discovered 1 warning sign about Kratos Defense & Security Solutions. View them for free.

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 Kratos Defense & Security Solutions, this is the formula:

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

0.02 = US$33m ÷ (US$2.0b - US$297m) (Based on the trailing twelve months to December 2024).

Thus, Kratos Defense & Security Solutions has an ROCE of 2.0%. Ultimately, that's a low return and it under-performs the Aerospace & Defense industry average of 10.0%.

Check out our latest analysis for Kratos Defense & Security Solutions

In the above chart we have measured Kratos Defense & Security Solutions' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Kratos Defense & Security Solutions .

The Trend Of ROCE

Unfortunately, the trend isn't great with ROCE falling from 4.1% five years ago, while capital employed has grown 65%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. Kratos Defense & Security Solutions probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Kratos Defense & Security Solutions' reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 110% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

On a final note, we've found 1 warning sign for Kratos Defense & Security Solutions that we think you should be aware of.

While Kratos Defense & Security Solutions 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.