What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. So when we looked at Southern (NYSE:SO) and its trend of ROCE, we really liked what we saw.
Return On Capital Employed (ROCE): What Is It?
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 Southern is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.05 = US$6.0b ÷ (US$135b - US$14b) (Based on the trailing twelve months to March 2023).
Thus, Southern has an ROCE of 5.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 4.5%.
View our latest analysis for Southern
In the above chart we have measured Southern'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.
SWOT Analysis for Southern
- Earnings growth over the past year exceeded the industry.
- Interest payments on debt are not well covered.
- Dividend is low compared to the top 25% of dividend payers in the Electric Utilities market.
- Shareholders have been diluted in the past year.
- Annual earnings are forecast to grow for the next 3 years.
- Good value based on P/E ratio and estimated fair value.
- Debt is not well covered by operating cash flow.
- Paying a dividend but company has no free cash flows.
- Annual earnings are forecast to grow slower than the American market.
What The Trend Of ROCE Can Tell Us
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 5.0%. Basically the business is earning more per dollar of capital invested and in addition to that, 23% more capital is being employed now too. So we're very much inspired by what we're seeing at Southern thanks to its ability to profitably reinvest capital.
Our Take On Southern's ROCE
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Southern has. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 96% return over the last five years. In light of that, we think it's worth looking further into this stock because if Southern can keep these trends up, it could have a bright future ahead.
If you'd like to know more about Southern, we've spotted 4 warning signs, and 1 of them shouldn't be ignored.
While Southern may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.
About NYSE:SO
Southern
Through its subsidiaries, engages in the generation, transmission, and distribution of electricity.
Solid track record average dividend payer.
