AES' (NYSE:AES) Returns Have Hit A Wall

What are the early trends we should look for to identify a stock that could 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. Although, when we looked at AES (NYSE:AES), it didn't seem to tick all of these boxes.

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. The formula for this calculation on AES is:

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

0.074 = US$2.3b ÷ (US$38b - US$6.5b) (Based on the trailing twelve months to December 2022).

So, AES has an ROCE of 7.4%. On its own that's a low return, but compared to the average of 4.2% generated by the Renewable Energy industry, it's much better.

Check out our latest analysis for AES

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

The Trend Of ROCE

There hasn't been much to report for AES' returns and its level of capital employed because both metrics have been steady for the past five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So don't be surprised if AES doesn't end up being a multi-bagger in a few years time. This probably explains why AES is paying out 35% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.

Our Take On AES' ROCE

In summary, AES isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Yet to long term shareholders the stock has gifted them an incredible 141% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing to note, we've identified 2 warning signs with AES and understanding them should be part of your investment process.

While AES 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.