Global Water Resources' (NASDAQ:GWRS) Returns Have Hit A Wall
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Global Water Resources (NASDAQ:GWRS), it didn't seem to tick all of these boxes.
Understanding 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 Global Water Resources:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.027 = US$7.3m ÷ (US$283m - US$12m) (Based on the trailing twelve months to December 2020).
Thus, Global Water Resources has an ROCE of 2.7%. In absolute terms, that's a low return and it also under-performs the Water Utilities industry average of 4.1%.
Check out our latest analysis for Global Water Resources
In the above chart we have measured Global Water Resources' 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 Can We Tell From Global Water Resources' ROCE Trend?
In terms of Global Water Resources' historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 2.7% for the last five years, and the capital employed within the business has risen 20% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
The Key Takeaway
In summary, Global Water Resources has simply been reinvesting capital and generating the same low rate of return as before. Yet to long term shareholders the stock has gifted them an incredible 107% return in the last three years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Global Water Resources does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...
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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