Returns On Capital At Hydro One (TSE:H) Have Stalled

What trends should we look for it we want to identify stocks that can 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 briefly looking over the numbers, we don't think Hydro One (TSE:H) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is 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. To calculate this metric for Hydro One, this is the formula:

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

0.064 = CA$1.8b ÷ (CA$32b - CA$3.2b) (Based on the trailing twelve months to June 2023).

Therefore, Hydro One has an ROCE of 6.4%. On its own that's a low return, but compared to the average of 4.7% generated by the Electric Utilities industry, it's much better.

See 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 to see what analysts are forecasting going forward, you should check out our free report for Hydro One.

What Can We Tell From Hydro One's ROCE Trend?

There hasn't been much to report for Hydro One's returns and its level of capital employed because both metrics have been steady for the past five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So unless we see a substantial change at Hydro One in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. That being the case, it makes sense that Hydro One has been paying out 64% of its earnings to its shareholders. These mature businesses typically have reliable earnings and not many places to reinvest them, so the next best option is to put the earnings into shareholders pockets.

What We Can Learn From Hydro One's ROCE

In a nutshell, Hydro One has been trudging along with the same returns from the same amount of capital over the last five years. Yet to long term shareholders the stock has gifted them an incredible 113% 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.

One more thing: We've identified 2 warning signs with Hydro One (at least 1 which doesn't sit too well with us) , and understanding these would certainly be useful.

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. 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.