Severn Trent (LON:SVT) Is Reinvesting At Lower Rates Of Return

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Severn Trent (LON:SVT), we don't think it's current trends fit the mold of a multi-bagger.

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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. To calculate this metric for Severn Trent, this is the formula:

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 3.0% generated by the Water Utilities industry, it's much better.

Check out our latest analysis for Severn Trent

In the above chart we have measured Severn Trent'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 Severn Trent for free.

The Trend Of ROCE

When we looked at the ROCE trend at Severn Trent, we didn't gain much confidence. Around five years ago the returns on capital were 5.8%, but since then they've fallen to 3.8%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line On Severn Trent's ROCE

To conclude, we've found that Severn Trent is reinvesting in the business, but returns have been falling. And with the stock having returned a mere 39% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing, we've spotted 2 warning signs facing Severn Trent that you might find interesting.

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

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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.