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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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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 investigating Essential Utilities (NYSE:WTRG), we don't think it's current trends fit the mold of a multi-bagger.
Understanding 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. To calculate this metric for Essential Utilities, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.043 = US$696m ÷ (US$17b - US$798m) (Based on the trailing twelve months to December 2023).
Therefore, Essential Utilities has an ROCE of 4.3%. On its own that's a low return on capital but it's in line with the industry's average returns of 4.1%.
View our latest analysis for Essential Utilities
Above you can see how the current ROCE for Essential Utilities compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Essential Utilities .
What Does the ROCE Trend For Essential Utilities Tell Us?
There are better returns on capital out there than what we're seeing at Essential Utilities. Over the past five years, ROCE has remained relatively flat at around 4.3% and the business has deployed 144% more capital into its operations. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
In Conclusion...
In summary, Essential Utilities has simply been reinvesting capital and generating the same low rate of return as before. Unsurprisingly, the stock has only gained 9.6% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
One final note, you should learn about the 3 warning signs we've spotted with Essential Utilities (including 1 which is potentially serious) .
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.