What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, we've noticed some promising trends at Energy Recovery (NASDAQ:ERII) so let's look a bit deeper.
What is 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. Analysts use this formula to calculate it for Energy Recovery:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.068 = US$13m ÷ (US$209m - US$16m) (Based on the trailing twelve months to September 2021).
Therefore, Energy Recovery has an ROCE of 6.8%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 10%.
In the above chart we have measured Energy Recovery's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Energy Recovery here for free.
The Trend Of ROCE
The fact that Energy Recovery is now generating some pre-tax profits from its prior investments is very encouraging. About five years ago the company was generating losses but things have turned around because it's now earning 6.8% on its capital. And unsurprisingly, like most companies trying to break into the black, Energy Recovery is utilizing 52% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
The Key Takeaway
In summary, it's great to see that Energy Recovery has managed to break into profitability and is continuing to reinvest in its business. And with a respectable 86% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing to note, we've identified 2 warning signs with Energy Recovery and understanding them should be part of your investment process.
While Energy Recovery isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.
Energy Recovery, Inc., together with its subsidiaries, designs, manufactures, and sells various solutions for the seawater reverse osmosis desalination and industrial wastewater treatment industries worldwide.
Flawless balance sheet with high growth potential.