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Here's What To Make Of National Grid's (LON:NG.) Returns On Capital

Simply Wall St
·3 min read

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at National Grid (LON:NG.), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for National Grid:

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

0.054 = UK£3.2b ÷ (UK£67b - UK£8.6b) (Based on the trailing twelve months to March 2020).

Therefore, National Grid has an ROCE of 5.4%. On its own that's a low return on capital but it's in line with the industry's average returns of 4.7%.

See our latest analysis for National Grid

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In the above chart we have measured National Grid's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering National Grid here for free.

What Can We Tell From National Grid's ROCE Trend?

The returns on capital haven't changed much for National Grid in recent years. The company has employed 23% more capital in the last five years, and the returns on that capital have remained stable at 5.4%. 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, National Grid has simply been reinvesting capital and generating the same low rate of return as before. Unsurprisingly, the stock has only gained 30% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One final note, you should learn about the 2 warning signs we've spotted with National Grid (including 1 which is shouldn't be ignored) .

While National Grid may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.