United Utilities Group (LON:UU.) Could Be At Risk Of Shrinking As A Company

What underlying fundamental trends can indicate that a company might be in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. And from a first read, things don't look too good at United Utilities Group (LON:UU.), so let's see why.

Understanding 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 United Utilities Group is:

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

0.032 = UK£446m ÷ (UK£15b - UK£576m) (Based on the trailing twelve months to March 2023).

Thus, United Utilities Group has an ROCE of 3.2%. On its own that's a low return on capital but it's in line with the industry's average returns of 2.8%.

See our latest analysis for United Utilities Group

Above you can see how the current ROCE for United Utilities Group 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 United Utilities Group here for free.

What Does the ROCE Trend For United Utilities Group Tell Us?

There is reason to be cautious about United Utilities Group, given the returns are trending downwards. About five years ago, returns on capital were 5.5%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on United Utilities Group becoming one if things continue as they have.

The Bottom Line On United Utilities Group's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 80% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing to note, we've identified 2 warning signs with United Utilities Group and understanding them should be part of your investment process.

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.