There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we’d want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Although, when we looked at American Water Works Company (NYSE:AWK), it didn’t seem to tick all of these boxes.
What is Return On Capital Employed (ROCE)?
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 American Water Works Company:
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).
So, American Water Works Company has an ROCE of 5.8%. On its own that’s a low return, but compared to the average of 4.2% generated by the Water Utilities industry, it’s much better.
See our latest analysis for American Water Works Company
In the above chart we have measured American Water Works Company’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 American Water Works Company.
The Trend Of ROCE
There are better returns on capital out there than what we’re seeing at American Water Works Company. 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. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don’t provide a high return on capital.
The Bottom Line
As we’ve seen above, American Water Works Company’s returns on capital haven’t increased but it is reinvesting in the business. Investors must think there’s better things to come because the stock has knocked it out of the park, delivering a 157% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn’t high.
One more thing, we’ve spotted 1 warning sign facing American Water Works Company that you might find interesting.
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.
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