What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at AusNet Services (ASX:AST), it didn't seem to tick all of these boxes.
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. To calculate this metric for AusNet Services, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.058 = AU$749m ÷ (AU$14b - AU$1.4b) (Based on the trailing twelve months to March 2020).
Thus, AusNet Services has an ROCE of 5.8%. On its own, that's a low figure but it's around the 4.8% average generated by the Electric Utilities industry.
In the above chart we have a measured AusNet Services' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for AusNet Services.
The Trend Of ROCE
In terms of AusNet Services' historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 5.8% for the last five years, and the capital employed within the business has risen 23% in that time. 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.
The Bottom Line
In summary, AusNet Services has simply been reinvesting capital and generating the same low rate of return as before. Although the market must be expecting these trends to improve because the stock has gained 60% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
AusNet Services does have some risks though, and we've spotted 3 warning signs for AusNet Services that you might be interested in.
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.
This article by Simply Wall St is general in nature. 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.
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