What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. And in light of that, the trends we're seeing at Centrica's (LON:CNA) look very promising so lets take a look.
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 Centrica:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = UK£2.1b ÷ (UK£17b - UK£6.9b) (Based on the trailing twelve months to June 2021).
Therefore, Centrica has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Integrated Utilities industry average of 6.1%.
In the above chart we have measured Centrica's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
Centrica has not disappointed in regards to ROCE growth. The figures show that over the last five years, returns on capital have grown by 32%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. In regards to capital employed, Centrica appears to been achieving more with less, since the business is using 24% less capital to run its operation. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.
On a side note, Centrica's current liabilities are still rather high at 40% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line On Centrica's ROCE
In a nutshell, we're pleased to see that Centrica has been able to generate higher returns from less capital. Astute investors may have an opportunity here because the stock has declined 59% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.
If you'd like to know about the risks facing Centrica, we've discovered 1 warning sign that you should be aware of.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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