If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Having said that, from a first glance at American States Water (NYSE:AWR) we aren’t jumping out of our chairs at how returns are trending, but let’s have a deeper look.
Return On Capital Employed (ROCE): What is it?
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. To calculate this metric for American States Water, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.085 = US$131m ÷ (US$1.7b – US$159m) (Based on the trailing twelve months to June 2020).
Thus, American States Water has an ROCE of 8.5%. On its own that’s a low return, but compared to the average of 3.4% generated by the Water Utilities industry, it’s much better.
Above you can see how the current ROCE for American States Water compares to its prior returns on capital, but there’s only so much you can tell from the past. If you’re interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is American States Water’s ROCE Trending?
There are better returns on capital out there than what we’re seeing at American States Water. The company has consistently earned 8.5% for the last five years, and the capital employed within the business has risen 23% in that time. 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
In summary, American States Water has simply been reinvesting capital and generating the same low rate of return as before. Although the market must be expecting these trends to improve because the stock has gained 87% over the last five years. However, unless these underlying trends turn more positive, we wouldn’t get our hopes up too high.
American States Water does have some risks though, and we’ve spotted 1 warning sign for American States Water that you might be interested in.
While American States Water 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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