There are a few key trends to look for if we want to identify the next multi-bagger. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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.
Understanding 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. 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)
0.055 = US$1.5b ÷ (US$30b - US$2.2b) (Based on the trailing twelve months to December 2023).
So, American Water Works Company has an ROCE of 5.5%. In absolute terms, that's a low return, but it's much better than the Water Utilities industry average of 4.1%.
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 analyst report for American Water Works Company .
How Are Returns Trending?
The returns on capital haven't changed much for American Water Works Company in recent years. Over the past five years, ROCE has remained relatively flat at around 5.5% and the business has deployed 47% more capital into its operations. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
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. And investors may be recognizing these trends since the stock has only returned a total of 25% to shareholders over the last five years. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
American Water Works Company does have some risks, we noticed 2 warning signs (and 1 which is potentially serious) we think you should know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.