If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at TransAlta Renewables (TSE:RNW) and its trend of ROCE, we really liked what we saw.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for TransAlta Renewables:

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

0.039 = CA$127m ÷ (CA$3.7b - CA$364m) (Based on the trailing twelve months to December 2020).

Therefore, TransAlta Renewables has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Renewable Energy industry average of 5.3%.

See our latest analysis for TransAlta Renewables

Above you can see how the current ROCE for TransAlta Renewables compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for TransAlta Renewables.

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. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 28% over the last five years. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.

What We Can Learn From TransAlta Renewables' ROCE

As discussed above, TransAlta Renewables appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has returned a staggering 102% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

TransAlta Renewables does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is potentially serious...

While TransAlta Renewables isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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