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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Speaking of which, we noticed some great changes in Southern's (NYSE:SO) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
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. Analysts use this formula to calculate it for Southern:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.045 = US$5.5b ÷ (US$134b - US$13b) (Based on the trailing twelve months to September 2022).
Thus, Southern has an ROCE of 4.5%. Even though it's in line with the industry average of 4.6%, it's still a low return by itself.
Check out 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 to see what analysts are forecasting going forward, you should check out our free report for Southern.
How Are Returns Trending?
We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. Over the last five years, returns on capital employed have risen substantially to 4.5%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 24%. 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
In summary, it's great to see that Southern can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with a respectable 86% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. 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.
Southern does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is a bit concerning...