Return Trends At Waterco (ASX:WAT) Aren't Appealing
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Having said that, from a first glance at Waterco (ASX:WAT) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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 Waterco, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.064 = AU$7.8m ÷ (AU$155m - AU$33m) (Based on the trailing twelve months to December 2021).
So, Waterco has an ROCE of 6.4%. Ultimately, that's a low return and it under-performs the Leisure industry average of 13%.
See our latest analysis for Waterco
Historical performance is a great place to start when researching a stock so above you can see the gauge for Waterco's ROCE against it's prior returns. If you're interested in investigating Waterco's past further, check out this free graph of past earnings, revenue and cash flow.
What Can We Tell From Waterco's ROCE Trend?
There are better returns on capital out there than what we're seeing at Waterco. The company has employed 40% more capital in the last five years, and the returns on that capital have remained stable at 6.4%. 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 conclusion, Waterco 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 139% 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.
If you want to continue researching Waterco, you might be interested to know about the 2 warning signs that our analysis has discovered.
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.
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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.
