If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. However, after investigating Atmos Energy (NYSE:ATO), we don't think it's current trends fit the mold of a multi-bagger.
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 Atmos Energy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = US$863m ÷ (US$16b - US$798m) (Based on the trailing twelve months to December 2020).
So, Atmos Energy has an ROCE of 5.5%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.5%.
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 to see what analysts are forecasting going forward, you should check out our free report for Atmos Energy.
The Trend Of ROCE
On the surface, the trend of ROCE at Atmos Energy doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.5% from 7.9% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a related note, Atmos Energy has decreased its current liabilities to 4.8% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Key Takeaway
To conclude, we've found that Atmos Energy is reinvesting in the business, but returns have been falling. And with the stock having returned a mere 40% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
Atmos Energy does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is potentially serious...
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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