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American Electric Power Company (NASDAQ:AEP) May Have Issues Allocating Its Capital

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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. However, after briefly looking over the numbers, we don't think American Electric Power Company (NASDAQ:AEP) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for American Electric Power Company:

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

0.044 = US$3.3b ÷ (US$84b - US$10b) (Based on the trailing twelve months to June 2021).

Therefore, American Electric Power Company has an ROCE of 4.4%. In absolute terms, that's a low return but it's around the Electric Utilities industry average of 4.6%.

View our latest analysis for American Electric Power Company

roce
roce

Above you can see how the current ROCE for American Electric Power Company 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 American Electric Power Company here for free.

So How Is American Electric Power Company's ROCE Trending?

When we looked at the ROCE trend at American Electric Power Company, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.4% from 5.8% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

In Conclusion...

To conclude, we've found that American Electric Power Company is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 58% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

On a separate note, we've found 1 warning sign for American Electric Power Company you'll probably want to know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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.

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