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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? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Avista (NYSE:AVA) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Avista:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.043 = US$246m ÷ (US$6.6b - US$892m) (Based on the trailing twelve months to June 2021).
So, Avista has an ROCE of 4.3%. On its own, that's a low figure but it's around the 4.6% average generated by the Integrated Utilities industry.
In the above chart we have measured Avista'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.
What Can We Tell From Avista's ROCE Trend?
We weren't thrilled with the trend because Avista's ROCE has reduced by 29% over the last five years, while the business employed 26% more capital. That being said, Avista raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Avista might not have received a full period of earnings contribution from it.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by Avista's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 12% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.
Avista does have some risks, we noticed 3 warning signs (and 1 which shouldn't be ignored) we think 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.
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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