Pinnacle West Capital (NYSE:PNW) Is Reinvesting At Lower Rates Of Return

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. 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 Pinnacle West Capital (NYSE:PNW) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Pinnacle West Capital is:

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

0.037 = US$842m ÷ (US$24b - US$2.0b) (Based on the trailing twelve months to September 2023).

So, Pinnacle West Capital has an ROCE of 3.7%. Even though it's in line with the industry average of 4.4%, it's still a low return by itself.

Check out our latest analysis for Pinnacle West Capital

Above you can see how the current ROCE for Pinnacle West Capital 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 Pinnacle West Capital here for free.

So How Is Pinnacle West Capital's ROCE Trending?

When we looked at the ROCE trend at Pinnacle West Capital, we didn't gain much confidence. Around five years ago the returns on capital were 5.2%, but since then they've fallen to 3.7%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Our Take On Pinnacle West Capital's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Pinnacle West Capital is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 5.3% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

Pinnacle West Capital does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit concerning...

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.