Returns On Capital At Energy Recovery (NASDAQ:ERII) Paint A Concerning Picture

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Energy Recovery (NASDAQ:ERII) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is 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 Energy Recovery, this is the formula:

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

0.045 = US$8.8m ÷ (US$210m - US$15m) (Based on the trailing twelve months to June 2023).

So, Energy Recovery has an ROCE of 4.5%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 12%.

See our latest analysis for Energy Recovery

Above you can see how the current ROCE for Energy Recovery 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 Energy Recovery here for free.

So How Is Energy Recovery's ROCE Trending?

On the surface, the trend of ROCE at Energy Recovery doesn't inspire confidence. Around five years ago the returns on capital were 7.9%, but since then they've fallen to 4.5%. 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 Energy Recovery's ROCE

Bringing it all together, while we're somewhat encouraged by Energy Recovery's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 169% 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 continue researching Energy Recovery, you might be interested to know about the 1 warning sign that our analysis has discovered.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.