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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at American States Water (NYSE:AWR) and its ROCE trend, we weren't exactly thrilled.
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. The formula for this calculation on American States Water is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.081 = US$141m ÷ (US$1.8b - US$111m) (Based on the trailing twelve months to June 2021).
So, American States Water has an ROCE of 8.1%. On its own that's a low return, but compared to the average of 4.6% generated by the Water Utilities industry, it's much better.
Above you can see how the current ROCE for American States Water 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 States Water here for free.
So How Is American States Water's ROCE Trending?
There are better returns on capital out there than what we're seeing at American States Water. The company has employed 39% more capital in the last five years, and the returns on that capital have remained stable at 8.1%. 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 American States Water's ROCE
In conclusion, American States Water has been investing more capital into the business, but returns on that capital haven't increased. Yet to long term shareholders the stock has gifted them an incredible 149% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
American States Water does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is potentially serious...
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. 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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