If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Having said that, from a first glance at AGL Energy (ASX:AGL) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What Is Return On Capital Employed (ROCE)?
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. To calculate this metric for AGL Energy, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = AU$1.4b ÷ (AU$16b - AU$4.6b) (Based on the trailing twelve months to June 2024).
So, AGL Energy has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 5.5% generated by the Integrated Utilities industry.
See our latest analysis for AGL Energy
Above you can see how the current ROCE for AGL Energy 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 analyst report for AGL Energy .
What Can We Tell From AGL Energy's ROCE Trend?
Over the past five years, AGL Energy's ROCE and capital employed have both remained mostly flat. 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. So unless we see a substantial change at AGL Energy in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. This probably explains why AGL Energy is paying out 56% of its income to shareholders in the form of dividends. Unless businesses have highly compelling growth opportunities, they'll typically return some money to shareholders.
On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 29% of total assets, this reported ROCE would probably be less than13% because total capital employed would be higher.The 13% ROCE could be even lower if current liabilities weren't 29% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.
In Conclusion...
In a nutshell, AGL Energy has been trudging along with the same returns from the same amount of capital over the last five years. And investors appear hesitant that the trends will pick up because the stock has fallen 29% in the last five years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
If you'd like to know more about AGL Energy, we've spotted 2 warning signs, and 1 of them is potentially serious.
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.
About ASX:AGL
AGL Energy
Engages in the supply of energy and other essential services to residential, business, and wholesale customers in Australia.
Established dividend payer with adequate balance sheet.
