To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Northland Power (TSE:NPI), we don't think it's current trends fit the mold of a multi-bagger.
What Is Return On Capital Employed (ROCE)?
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. The formula for this calculation on Northland Power is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.082 = CA$955m ÷ (CA$13b - CA$1.5b) (Based on the trailing twelve months to June 2022).
So, Northland Power has an ROCE of 8.2%. On its own that's a low return, but compared to the average of 3.9% generated by the Renewable Energy industry, it's much better.
In the above chart we have measured Northland Power's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Northland Power.
What Can We Tell From Northland Power's ROCE Trend?
There are better returns on capital out there than what we're seeing at Northland Power. The company has consistently earned 8.2% for the last five years, and the capital employed within the business has risen 36% 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.
Our Take On Northland Power's ROCE
As we've seen above, Northland Power's returns on capital haven't increased but it is reinvesting in the business. Yet to long term shareholders the stock has gifted them an incredible 130% return in the last five years, so the market appears to be rosy about its future. 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 4 warning signs for Northland Power (of which 1 doesn't sit too well with us!) that you should know about.
While Northland Power isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here