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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at American Water Works Company (NYSE:AWK) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on American Water Works Company is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.054 = US$1.5b ÷ (US$30b - US$1.7b) (Based on the trailing twelve months to September 2023).
Thus, American Water Works Company has an ROCE of 5.4%. In absolute terms, that's a low return, but it's much better than the Water Utilities industry average of 4.1%.
View 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.
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 5.4% for the last five years, and the capital employed within the business has risen 47% 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 On American Water Works Company's ROCE
Long story short, while American Water Works Company has been reinvesting its capital, the returns that it's generating haven't increased. Although the market must be expecting these trends to improve because the stock has gained 54% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
If you want to know some of the risks facing American Water Works Company we've found 4 warning signs (1 is significant!) that you should be aware of before investing here.
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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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.