The Returns On Capital At ALLETE (NYSE:ALE) Don't Inspire Confidence

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. Although, when we looked at ALLETE (NYSE:ALE), it didn't seem to tick all of these boxes.

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. Analysts use this formula to calculate it for ALLETE:

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

0.028 = US$170m ÷ (US$6.6b - US$557m) (Based on the trailing twelve months to March 2022).

Thus, ALLETE has an ROCE of 2.8%. In absolute terms, that's a low return and it also under-performs the Electric Utilities industry average of 4.8%.

Check out our latest analysis for ALLETE

In the above chart we have measured ALLETE'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 ALLETE here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at ALLETE doesn't inspire confidence. Around five years ago the returns on capital were 4.8%, but since then they've fallen to 2.8%. 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.

Our Take On ALLETE's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that ALLETE is reinvesting for growth and has higher sales as a result. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

ALLETE does have some risks, we noticed 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.