Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. However, after briefly looking over the numbers, we don't think Southern (NYSE:SO) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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 Southern:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = US$5.6b ÷ (US$138b - US$13b) (Based on the trailing twelve months to September 2023).
Thus, Southern has an ROCE of 4.4%. Even though it's in line with the industry average of 4.4%, it's still a low return by itself.
See our latest analysis for Southern
Above you can see how the current ROCE for Southern 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 Southern here for free.
What Can We Tell From Southern's ROCE Trend?
The returns on capital haven't changed much for Southern in recent years. The company has employed 27% more capital in the last five years, and the returns on that capital have remained stable at 4.4%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
In Conclusion...
Long story short, while Southern has been reinvesting its capital, the returns that it's generating haven't increased. Although the market must be expecting these trends to improve because the stock has gained 91% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
On a separate note, we've found 2 warning signs for Southern you'll probably want to know about.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.
About NYSE:SO
Southern
Through its subsidiaries, engages in the generation, transmission, and distribution of electricity.
Solid track record average dividend payer.
