What trends should we look for it we want to identify stocks that can multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Hydro One (TSE:H), 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. Analysts use this formula to calculate it for Hydro One:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.062 = CA$1.8b ÷ (CA$31b - CA$2.3b) (Based on the trailing twelve months to March 2023).
So, Hydro One has an ROCE of 6.2%. On its own that's a low return, but compared to the average of 4.7% generated by the Electric Utilities industry, it's much better.
In the above chart we have measured Hydro One's 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 Hydro One.
What Does the ROCE Trend For Hydro One Tell Us?
The returns on capital haven't changed much for Hydro One in recent years. The company has consistently earned 6.2% for the last five years, and the capital employed within the business has risen 27% in that time. 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.
The Bottom Line
In conclusion, Hydro One has been investing more capital into the business, but returns on that capital haven't increased. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 145% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Hydro One (of which 1 is a bit concerning!) that you should know about.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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