The Returns On Capital At Severn Trent (LON:SVT) Don't Inspire Confidence

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. However, after briefly looking over the numbers, we don't think Severn Trent (LON:SVT) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

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. 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£496m ÷ (UK£11b - UK£958m) (Based on the trailing twelve months to September 2021).

Thus, Severn Trent has an ROCE of 4.8%. Even though it's in line with the industry average of 4.6%, it's still a low return by itself.

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

The Trend Of ROCE

In terms of Severn Trent's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 6.4% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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

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. Since the stock has gained an impressive 53% 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.

If you'd like to know more about Severn Trent, we've spotted 3 warning signs, and 1 of them is concerning.

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.

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.