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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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Entergy (NYSE:ETR) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. The formula for this calculation on Entergy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.036 = US$1.9b ÷ (US$58b - US$7.1b) (Based on the trailing twelve months to December 2020).
So, Entergy has an ROCE of 3.6%. On its own that's a low return on capital but it's in line with the industry's average returns of 4.5%.
In the above chart we have measured Entergy's 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 report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
In terms of Entergy's historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 3.6% for the last five years, and the capital employed within the business has risen 23% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
What We Can Learn From Entergy's ROCE
As we've seen above, Entergy's returns on capital haven't increased but it is reinvesting in the business. Although the market must be expecting these trends to improve because the stock has gained 63% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
If you want to know some of the risks facing Entergy we've found 2 warning signs (1 is a bit concerning!) that you should be aware of before investing here.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
This article by Simply Wall St is general in nature. 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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