If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Mueller Water Products (NYSE:MWA) and its ROCE trend, we weren’t exactly thrilled.
Return On Capital Employed (ROCE): What is it?
For those who don’t know, ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Mueller Water Products:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.11 = US$126m ÷ (US$1.3b – US$145m) (Based on the trailing twelve months to June 2020).
Thus, Mueller Water Products has an ROCE of 11%. That’s a relatively normal return on capital, and it’s around the 9.1% generated by the Machinery industry.
In the above chart we have measured Mueller Water Products’ 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 Mueller Water Products here for free.
How Are Returns Trending?
There hasn’t been much to report for Mueller Water Products’ returns and its level of capital employed because both metrics have been steady for the past five years. It’s not uncommon to see this when looking at a mature and stable business that isn’t re-investing its earnings because it has likely passed that phase of the business cycle. With that in mind, unless investment picks up again in the future, we wouldn’t expect Mueller Water Products to be a multi-bagger going forward. This probably explains why Mueller Water Products is paying out 37% of its income to shareholders in the form of dividends. Given the business isn’t reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.
The Bottom Line On Mueller Water Products’ ROCE
In a nutshell, Mueller Water Products has been trudging along with the same returns from the same amount of capital over the last five years. Although the market must be expecting these trends to improve because the stock has gained 45% over the last five years. However, unless these underlying trends turn more positive, we wouldn’t get our hopes up too high.
On a final note, we’ve found 1 warning sign for Mueller Water Products that we think you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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This article by Simply Wall St is general in nature. 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.
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