Stock Analysis

There Are Reasons To Feel Uneasy About Algonquin Power & Utilities' (TSE:AQN) Returns On Capital

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TSX:AQN
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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Algonquin Power & Utilities (TSE:AQN), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

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. Analysts use this formula to calculate it for Algonquin Power & Utilities:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.029 = US$477m ÷ (US$18b - US$1.5b) (Based on the trailing twelve months to September 2023).

Therefore, Algonquin Power & Utilities has an ROCE of 2.9%. In absolute terms, that's a low return and it also under-performs the Integrated Utilities industry average of 5.1%.

See our latest analysis for Algonquin Power & Utilities

roce
TSX:AQN Return on Capital Employed December 3rd 2023

Above you can see how the current ROCE for Algonquin Power & Utilities compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Algonquin Power & Utilities.

The Trend Of ROCE

In terms of Algonquin Power & Utilities' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 4.4% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

What We Can Learn From Algonquin Power & Utilities' ROCE

Bringing it all together, while we're somewhat encouraged by Algonquin Power & Utilities' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 24% over the last five years, investors may not be too optimistic on this trend improving either. 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.

On a final note, we've found 2 warning signs for Algonquin Power & Utilities that we think you should be aware of.

While Algonquin Power & Utilities isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Valuation is complex, but we're helping make it simple.

Find out whether Algonquin Power & Utilities is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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