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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. 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 Pinnacle West Capital (NYSE:PNW) and its ROCE trend, we weren't exactly thrilled.
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. To calculate this metric for Pinnacle West Capital, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = US$884m ÷ (US$22b - US$1.6b) (Based on the trailing twelve months to September 2021).
Therefore, Pinnacle West Capital has an ROCE of 4.4%. Even though it's in line with the industry average of 4.5%, it's still a low return by itself.
Above you can see how the current ROCE for Pinnacle West Capital compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
When we looked at the ROCE trend at Pinnacle West Capital, we didn't gain much confidence. To be more specific, ROCE has fallen from 5.7% over the last five years. However it looks like Pinnacle West Capital might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
Our Take On Pinnacle West Capital's ROCE
Bringing it all together, while we're somewhat encouraged by Pinnacle West Capital's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 6.3% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
Pinnacle West Capital does have some risks, we noticed 2 warning signs (and 1 which is concerning) we think you should know about.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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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