Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think American Water Works Company (NYSE:AWK) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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 American Water Works Company, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.058 = US$1.3b ÷ (US$24b - US$2.3b) (Based on the trailing twelve months to September 2020).
Therefore, American Water Works Company has an ROCE of 5.8%. In absolute terms, that's a low return, but it's much better than the Water Utilities industry average of 4.2%.
Above you can see how the current ROCE for American Water Works Company compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for American Water Works Company.
What The Trend Of ROCE Can Tell Us
In terms of American Water Works Company's historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 5.8% for the last five years, and the capital employed within the business has risen 39% 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.
In summary, American Water Works Company has simply been reinvesting capital and generating the same low rate of return as before. Yet to long term shareholders the stock has gifted them an incredible 190% 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.
On a separate note, we've found 1 warning sign for American Water Works Company you'll probably want to know about.
While American Water Works Company isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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