What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. So when we looked at Southern (NYSE:SO) and its trend of ROCE, we really liked what we saw.
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 Southern:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.051 = US$6.4b ÷ (US$139b - US$13b) (Based on the trailing twelve months to December 2023).
Therefore, Southern has an ROCE of 5.1%. Even though it's in line with the industry average of 4.6%, it's still a low return by itself.
In the above chart we have measured Southern's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Southern for free.
So How Is Southern's ROCE Trending?
While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 5.1%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 23%. So we're very much inspired by what we're seeing at Southern thanks to its ability to profitably reinvest capital.
What We Can Learn From Southern's ROCE
In summary, it's great to see that Southern can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Since the stock has returned a solid 64% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. In light of that, we think it's worth looking further into this stock because if Southern can keep these trends up, it could have a bright future ahead.
Southern does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is a bit unpleasant...
While Southern 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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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.