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What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Severn Trent (LON:SVT), we don't think it's current trends fit the mold of a multi-bagger.
What Is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Severn Trent is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.046 = UK£505m ÷ (UK£12b - UK£1.1b) (Based on the trailing twelve months to March 2023).
So, Severn Trent has an ROCE of 4.6%. In absolute terms, that's a low return, but it's much better than the Water Utilities industry average of 2.8%.
View our latest analysis for Severn Trent
Above you can see how the current ROCE for Severn Trent 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 Severn Trent.
So How Is Severn Trent's ROCE Trending?
In terms of Severn Trent's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 6.1%, but since then they've fallen to 4.6%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
Our Take On Severn Trent's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Severn Trent. Furthermore the stock has climbed 58% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.
If you'd like to know more about Severn Trent, we've spotted 3 warning signs, and 2 of them don't sit too well with us.
While Severn Trent may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.