There Are Reasons To Feel Uneasy About American Water Works Company's (NYSE:AWK) Returns On Capital

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 American Water Works Company (NYSE:AWK) and its ROCE trend, we weren't exactly thrilled.

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 American Water Works Company:

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

0.052 = US$1.3b ÷ (US$27b - US$1.7b) (Based on the trailing twelve months to June 2022).

Thus, American Water Works Company has an ROCE of 5.2%. On its own that's a low return, but compared to the average of 4.3% generated by the Water Utilities industry, it's much better.

Our analysis indicates that AWK is potentially undervalued!

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. To be more specific, ROCE has fallen from 7.2% over the last five years. However it looks like American Water Works Company might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line On American Water Works Company's ROCE

In summary, American Water Works Company is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has gained an impressive 63% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

American Water Works Company does have some risks, we noticed 3 warning signs (and 1 which is a bit unpleasant) 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.