Returns On Capital At Northland Power (TSE:NPI) 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? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after investigating Northland Power (TSE:NPI), 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 Northland Power:

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

0.068 = CA$778m ÷ (CA$13b - CA$1.4b) (Based on the trailing twelve months to December 2021).

So, Northland Power has an ROCE of 6.8%. On its own that's a low return, but compared to the average of 3.8% generated by the Renewable Energy industry, it's much better.

Check out our latest analysis for Northland Power

In the above chart we have measured Northland Power's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Northland Power's ROCE Trending?

In terms of Northland Power's historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 6.8% for the last five years, and the capital employed within the business has risen 40% in that time. 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 Bottom Line

In conclusion, Northland Power has been investing more capital into the business, but returns on that capital haven't increased. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 102% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One final note, you should learn about the 4 warning signs we've spotted with Northland Power (including 1 which makes us a bit uncomfortable) .

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.