To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Having said that, from a first glance at American Electric Power Company (NASDAQ:AEP) 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 American Electric Power Company, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = US$3.3b ÷ (US$84b - US$10b) (Based on the trailing twelve months to June 2021).
Therefore, American Electric Power Company has an ROCE of 4.4%. In absolute terms, that's a low return but it's around the Electric Utilities industry average of 4.6%.
In the above chart we have measured American Electric Power Company's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From American Electric Power Company's ROCE Trend?
On the surface, the trend of ROCE at American Electric Power Company doesn't inspire confidence. Around five years ago the returns on capital were 5.8%, but since then they've fallen to 4.4%. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
What We Can Learn From American Electric Power Company's ROCE
Bringing it all together, while we're somewhat encouraged by American Electric Power Company's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 50% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
If you'd like to know about the risks facing American Electric Power Company, we've discovered 1 warning sign that you should be aware of.
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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.
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