Stock Analysis

Severn Trent (LON:SVT) Will Be Hoping To Turn Its Returns On Capital Around

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LSE:SVT
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There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 Severn Trent (LON:SVT), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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. The formula for this calculation on Severn Trent is:

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

0.048 = UK£500m ÷ (UK£12b - UK£1.1b) (Based on the trailing twelve months to March 2022).

So, Severn Trent has an ROCE of 4.8%. Even though it's in line with the industry average of 4.8%, it's still a low return by itself.

View our latest analysis for Severn Trent

roce
LSE:SVT Return on Capital Employed July 15th 2022

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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

On the surface, the trend of ROCE at Severn Trent doesn't inspire confidence. Around five years ago the returns on capital were 6.2%, but since then they've fallen to 4.8%. 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 Key Takeaway

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. Although the market must be expecting these trends to improve because the stock has gained 55% over the last five years. 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 spotted 2 warning signs facing Severn Trent that you might find interesting.

While Severn Trent may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

Valuation is complex, but we're helping make it simple.

Find out whether Severn Trent is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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About LSE:SVT

Severn Trent

Severn Trent Plc operates as a water and sewerage company in England and Wales.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation0
Future Growth4
Past Performance2
Financial Health0
Dividends3

Read more about these checks in the individual report sections or in our analysis model.

Reasonable growth potential second-rate dividend payer.