What are the early trends we should look for to identify a stock that could 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at TransAlta Renewables (TSE:RNW) so let's look a bit deeper.
Return On Capital Employed (ROCE): What is it?
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. To calculate this metric for TransAlta Renewables, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = CA$132m ÷ (CA$3.6b - CA$178m) (Based on the trailing twelve months to September 2020).
Thus, TransAlta Renewables has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Renewable Energy industry average of 7.7%.
Above you can see how the current ROCE for TransAlta Renewables compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering TransAlta Renewables here for free.
How Are Returns Trending?
While there are companies with higher returns on capital out there, we still find the trend at TransAlta Renewables promising. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 24% over the last five years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.
What We Can Learn From TransAlta Renewables' ROCE
To sum it up, TransAlta Renewables is collecting higher returns from the same amount of capital, and that's impressive. Since the stock has returned a staggering 150% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
If you want to know some of the risks facing TransAlta Renewables we've found 3 warning signs (1 is concerning!) that you should be aware of before investing here.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
This article by Simply Wall St is general in nature. 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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