Capital Allocation Trends At Middlesex Water (NASDAQ:MSEX) Aren't Ideal

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. 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 Middlesex Water (NASDAQ:MSEX) 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. The formula for this calculation on Middlesex Water is:

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

0.04 = US$37m ÷ (US$986m - US$66m) (Based on the trailing twelve months to March 2021).

Thus, Middlesex Water has an ROCE of 4.0%. In absolute terms, that's a low return but it's around the Water Utilities industry average of 4.6%.

View our latest analysis for Middlesex Water

Above you can see how the current ROCE for Middlesex Water compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

In terms of Middlesex Water's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 6.7%, but since then they've fallen to 4.0%. However it looks like Middlesex Water might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Middlesex Water's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 175% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Middlesex Water does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit unpleasant...

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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