What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at FirstEnergy (NYSE:FE), it didn’t seem to tick all of these boxes.
What is Return On Capital Employed (ROCE)?
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for FirstEnergy, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.032 = US$1.3b ÷ (US$43b – US$3.1b) (Based on the trailing twelve months to September 2020).
Therefore, FirstEnergy has an ROCE of 3.2%. Ultimately, that’s a low return and it under-performs the Electric Utilities industry average of 4.5%.
See our latest analysis for FirstEnergy
In the above chart we have measured FirstEnergy’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 FirstEnergy.
What Does the ROCE Trend For FirstEnergy Tell Us?
Things have been pretty stable at FirstEnergy, with its capital employed and returns on that capital staying somewhat the same for the last five years. This tells us the company isn’t reinvesting in itself, so it’s plausible that it’s past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn’t expect FirstEnergy to be a multi-bagger going forward. With fewer investment opportunities, it makes sense that FirstEnergy has been paying out a decent 58% of its earnings to shareholders. Unless businesses have highly compelling growth opportunities, they’ll typically return some money to shareholders.
In a nutshell, FirstEnergy has been trudging along with the same returns from the same amount of capital over the last five years. And investors may be recognizing these trends since the stock has only returned a total of 21% to shareholders over the last five years. Therefore, if you’re looking for a multi-bagger, we’d propose looking at other options.
FirstEnergy does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those can’t be ignored…
While FirstEnergy may not currently earn the highest returns, we’ve compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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