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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. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Consolidated Water (NASDAQ:CWCO), we don't think it's current trends fit the mold of a multi-bagger.
Understanding 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. To calculate this metric for Consolidated Water, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.046 = US$8.0m ÷ (US$180m - US$7.7m) (Based on the trailing twelve months to September 2020).
Therefore, Consolidated Water has an ROCE of 4.6%. In absolute terms, that's a low return but it's around the Water Utilities industry average of 4.2%.
In the above chart we have measured Consolidated Water's 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.
How Are Returns Trending?
Over the past five years, Consolidated Water's ROCE and capital employed have both remained mostly flat. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect Consolidated Water to be a multi-bagger going forward.
The Bottom Line On Consolidated Water's ROCE
In summary, Consolidated Water isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Since the stock has gained an impressive 42% 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.
On a separate note, we've found 1 warning sign for Consolidated Water you'll probably want to know about.
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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