Returns On Capital Signal Tricky Times Ahead For American Water Works Company (NYSE:AWK)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at American Water Works Company (NYSE:AWK) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for American Water Works Company, this is the formula:

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

0.052 = US$1.3b ÷ (US$27b - US$2.1b) (Based on the trailing twelve months to September 2022).

Therefore, American Water Works Company has an ROCE of 5.2%. On its own, that's a low figure but it's around the 4.5% average generated by the Water Utilities industry.

Check out our latest analysis for American Water Works Company

Above you can see how the current ROCE for American Water Works Company 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 American Water Works Company here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at American Water Works Company doesn't inspire confidence. Around five years ago the returns on capital were 7.1%, but since then they've fallen to 5.2%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by American Water Works Company'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 112% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One final note, you should learn about the 3 warning signs we've spotted with American Water Works Company (including 1 which makes us a bit uncomfortable) .

While American Water Works Company 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.