What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at Terna (BIT:TRN) and its ROCE trend, we weren't exactly thrilled.
What Is 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. Analysts use this formula to calculate it for Terna:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.082 = €1.4b ÷ (€23b - €5.9b) (Based on the trailing twelve months to June 2023).
So, Terna has an ROCE of 8.2%. On its own, that's a low figure but it's around the 9.2% average generated by the Electric Utilities industry.
In the above chart we have measured Terna's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Terna.
What The Trend Of ROCE Can Tell Us
The returns on capital haven't changed much for Terna in recent years. The company has consistently earned 8.2% for the last five years, and the capital employed within the business has risen 31% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
The Bottom Line On Terna's ROCE
Long story short, while Terna has been reinvesting its capital, the returns that it's generating haven't increased. Yet to long term shareholders the stock has gifted them an incredible 101% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
If you want to know some of the risks facing Terna we've found 2 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.
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.
Valuation is complex, but we're helping make it simple.
Find out whether Terna 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.View the Free Analysis
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.