Returns On Capital At Hydro One (TSE:H) Have Hit The Brakes

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Hydro One (TSE:H), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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 Hydro One:

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

0.063 = CA$1.8b ÷ (CA$32b - CA$3.0b) (Based on the trailing twelve months to September 2023).

Thus, Hydro One has an ROCE of 6.3%. In absolute terms, that's a low return, but it's much better than the Electric Utilities industry average of 4.6%.

Check out our latest analysis for Hydro One

In the above chart we have measured Hydro One'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 Hydro One here for free.

What Does the ROCE Trend For Hydro One Tell Us?

There are better returns on capital out there than what we're seeing at Hydro One. The company has employed 20% more capital in the last five years, and the returns on that capital have remained stable at 6.3%. 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 Key Takeaway

As we've seen above, Hydro One's returns on capital haven't increased but it is reinvesting in the business. Yet to long term shareholders the stock has gifted them an incredible 134% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

On a final note, we found 2 warning signs for Hydro One (1 is a bit concerning) you should be aware of.

While Hydro One 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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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.