Returns On Capital At California Water Service Group (NYSE:CWT) Paint A Concerning Picture

There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating California Water Service Group (NYSE:CWT), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for California Water Service Group:

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

0.029 = US$104m ÷ (US$4.0b - US$363m) (Based on the trailing twelve months to June 2023).

So, California Water Service Group has an ROCE of 2.9%. In absolute terms, that's a low return and it also under-performs the Water Utilities industry average of 4.4%.

See our latest analysis for California Water Service Group

Above you can see how the current ROCE for California Water Service Group 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 California Water Service Group here for free.

The Trend Of ROCE

When we looked at the ROCE trend at California Water Service Group, we didn't gain much confidence. Around five years ago the returns on capital were 5.9%, but since then they've fallen to 2.9%. 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 may take some time before the company starts to see any change in earnings from these investments.

On a related note, California Water Service Group has decreased its current liabilities to 9.1% of total assets. So we could link some of this to the decrease in ROCE. 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. 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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by California Water Service Group's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 42% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

If you want to know some of the risks facing California Water Service Group we've found 3 warning signs (2 make us uncomfortable!) that you should be aware of before investing here.

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.