What are the early trends we should look for to identify a stock that could 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at MGE Energy (NASDAQ:MGEE), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for MGE Energy:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.059 = US$122m ÷ (US$2.2b - US$110m) (Based on the trailing twelve months to June 2020).
Therefore, MGE Energy has an ROCE of 5.9%. On its own that's a low return, but compared to the average of 4.7% generated by the Electric Utilities industry, it's much better.
Above you can see how the current ROCE for MGE Energy 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.
So How Is MGE Energy's ROCE Trending?
The trend of ROCE doesn't look fantastic because it's fallen from 7.8% five years ago, while the business's capital employed increased by 27%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence MGE Energy might not have received a full period of earnings contribution from it. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.
To conclude, we've found that MGE Energy is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 90% 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.
One more thing to note, we've identified 2 warning signs with MGE Energy and understanding them should be part of your investment process.
While MGE Energy 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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