Be Wary Of Severn Trent (LON:SVT) And Its Returns On Capital
If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Severn Trent (LON:SVT) 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 Severn Trent, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.043 = UK£494m ÷ (UK£13b - UK£1.3b) (Based on the trailing twelve months to September 2023).
Therefore, Severn Trent has an ROCE of 4.3%. On its own that's a low return on capital but it's in line with the industry's average returns of 4.1%.
See our latest analysis for Severn Trent
In the above chart we have measured Severn Trent's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Severn Trent.
The Trend Of ROCE
When we looked at the ROCE trend at Severn Trent, we didn't gain much confidence. To be more specific, ROCE has fallen from 6.1% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that Severn Trent is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 69% to shareholders over the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
If you want to know some of the risks facing Severn Trent we've found 4 warning signs (2 are a bit concerning!) that you should be aware of before investing here.
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.
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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.
