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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in Southern's (NYSE:SO) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What Is It?
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. To calculate this metric for Southern, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.05 = US$6.0b ÷ (US$135b - US$14b) (Based on the trailing twelve months to March 2023).
Therefore, Southern has an ROCE of 5.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 4.5%.
View our latest analysis for Southern
In the above chart we have measured Southern's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Southern here for free.
What Does the ROCE Trend For Southern Tell Us?
We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. The data shows that returns on capital have increased substantially over the last five years to 5.0%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 23%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
What We Can Learn From Southern's ROCE
In summary, it's great to see that Southern can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 97% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Southern (of which 1 is significant!) that you should know about.
While Southern 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.
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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.