If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out 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. Although, when we looked at Emera (TSE:EMA), it didn't seem to tick all of these boxes.
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. Analysts use this formula to calculate it for Emera:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.043 = CA$1.2b ÷ (CA$32b - CA$4.3b) (Based on the trailing twelve months to September 2020).
So, Emera has an ROCE of 4.3%. In absolute terms, that's a low return but it's around the Electric Utilities industry average of 4.6%.
In the above chart we have measured Emera'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 Emera here for free.
The Trend Of ROCE
When we looked at the ROCE trend at Emera, we didn't gain much confidence. Around five years ago the returns on capital were 6.7%, but since then they've fallen to 4.3%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
The Key Takeaway
From the above analysis, we find it rather worrisome that returns on capital and sales for Emera have fallen, meanwhile the business is employing more capital than it was five years ago. However the stock has delivered a 52% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
Emera does have some risks, we noticed 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.
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. 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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