Returns On Capital At Severn Trent (LON:SVT) Paint A Concerning Picture

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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Severn Trent (LON:SVT), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Severn Trent is:

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

0.038 = UK£540m ÷ (UK£15b - UK£818m) (Based on the trailing twelve months to September 2024).

Therefore, Severn Trent has an ROCE of 3.8%. On its own that's a low return, but compared to the average of 3.1% generated by the Water Utilities industry, it's much better.

Check out our latest analysis for Severn Trent

Above you can see how the current ROCE for Severn Trent compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Severn Trent for free.

What Can We Tell From Severn Trent's ROCE Trend?

In terms of Severn Trent's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 3.8% from 5.8% five years ago. However it looks like Severn Trent might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Severn Trent's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 24% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

If you'd like to know more about Severn Trent, we've spotted 3 warning signs, and 2 of them are a bit concerning.

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.