If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. In light of that, when we looked at Atmos Energy (NYSE:ATO) and its ROCE trend, we weren't exactly thrilled.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Atmos Energy, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.05 = US$904m ÷ (US$19b - US$1.1b) (Based on the trailing twelve months to June 2021).
Thus, Atmos Energy has an ROCE of 5.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.4%.
In the above chart we have measured Atmos Energy'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 Atmos Energy here for free.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Atmos Energy, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.0% from 7.9% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
On a related note, Atmos Energy has decreased its current liabilities to 5.5% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
Our Take On Atmos Energy's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Atmos Energy is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 46% to shareholders over the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
Atmos Energy does come with some risks though, we found 4 warning signs in our investment analysis, and 2 of those are a bit concerning...
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.
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