There Are Reasons To Feel Uneasy About MGE Energy's (NASDAQ:MGEE) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at MGE Energy (NASDAQ:MGEE) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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 MGE Energy, this is the formula:

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

0.06 = US$137m ÷ (US$2.4b - US$98m) (Based on the trailing twelve months to March 2022).

So, MGE Energy has an ROCE of 6.0%. On its own that's a low return, but compared to the average of 4.8% generated by the Electric Utilities industry, it's much better.

Check out our latest analysis for MGE Energy

In the above chart we have measured MGE Energy'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 MGE Energy.

How Are Returns Trending?

When we looked at the ROCE trend at MGE Energy, we didn't gain much confidence. Around five years ago the returns on capital were 7.7%, but since then they've fallen to 6.0%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line On MGE Energy's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for MGE Energy. In light of this, the stock has only gained 33% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

On a separate note, we've found 2 warning signs for MGE Energy you'll probably want to know about.

While MGE Energy may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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.