Slowing Rates Of Return At Northland Power (TSE:NPI) Leave Little Room For Excitement

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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. In light of that, when we looked at Northland Power (TSE:NPI) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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)

0.082 = CA$955m ÷ (CA$13b - CA$1.5b) (Based on the trailing twelve months to June 2022).

Thus, Northland Power has an ROCE of 8.2%. On its own that's a low return, but compared to the average of 3.9% generated by the Renewable Energy industry, it's much better.

Check out the opportunities and risks within the CA Renewable Energy industry.

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?

There are better returns on capital out there than what we're seeing at Northland Power. Over the past five years, ROCE has remained relatively flat at around 8.2% and the business has deployed 36% more capital into its operations. 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 On Northland Power's ROCE

In conclusion, Northland Power has been investing more capital into the business, but returns on that capital haven't increased. Since the stock has gained an impressive 91% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

On a final note, we found 4 warning signs for Northland Power (1 doesn't sit too well with us) you should be aware of.

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. 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.