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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'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. However, after investigating Avista (NYSE:AVA), we don't think it's current trends fit the mold of a multi-bagger.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Avista, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.038 = US$226m ÷ (US$6.4b - US$506m) (Based on the trailing twelve months to December 2020).
Thus, Avista has an ROCE of 3.8%. On its own, that's a low figure but it's around the 4.7% average generated by the Integrated Utilities industry.
In the above chart we have measured Avista'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.
The Trend Of ROCE
The trend of ROCE doesn't look fantastic because it's fallen from 5.7% five years ago, while the business's capital employed increased by 33%. That being said, Avista raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Avista probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt. It's also worth noting the company's latest EBIT figure is within 10% of the previous year, so it's fair to assign the ROCE drop largely to the capital raise.
The Bottom Line
To conclude, we've found that Avista is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 43% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
If you'd like to know more about Avista, we've spotted 4 warning signs, and 1 of them is concerning.
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. 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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