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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. In light of that, when we looked at Eversource Energy (NYSE:ES) and its ROCE trend, we weren't exactly thrilled.
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. To calculate this metric for Eversource Energy, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.051 = US$2.0b ÷ (US$42b - US$3.3b) (Based on the trailing twelve months to June 2020).
Therefore, Eversource Energy has an ROCE of 5.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 4.6%.
Above you can see how the current ROCE for Eversource Energy 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 Eversource Energy here for free.
The Trend Of ROCE
Unfortunately, the trend isn't great with ROCE falling from 6.6% five years ago, while capital employed has grown 43%. That being said, Eversource Energy raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Eversource Energy's earnings and if they change as a result from the capital raise. 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.
What We Can Learn From Eversource Energy's ROCE
To conclude, we've found that Eversource Energy is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 88% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Eversource Energy (of which 1 is a bit unpleasant!) that you should 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. 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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