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'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think American States Water (NYSE:AWR) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What is it?
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 States Water, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.08 = US$129m ÷ (US$1.7b - US$113m) (Based on the trailing twelve months to September 2020).
So, American States Water has an ROCE of 8.0%. On its own that's a low return, but compared to the average of 4.2% generated by the Water Utilities industry, it's much better.
In the above chart we have measured American States Water's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
There are better returns on capital out there than what we're seeing at American States Water. The company has consistently earned 8.0% for the last five years, and the capital employed within the business has risen 30% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
The Key Takeaway
In summary, American States Water has simply been reinvesting capital and generating the same low rate of return as before. Yet to long term shareholders the stock has gifted them an incredible 120% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
One more thing to note, we've identified 1 warning sign with American States Water and understanding this should be part of your investment process.
While American States Water 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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American States Water
American States Water Company, through its subsidiaries, provides water and electric services to residential, commercial, industrial, and other customers in the United States.
Average dividend payer with questionable track record.