Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Southern (NYSE:SO) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. The formula for this calculation on Southern is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.058 = US$7.6b ÷ (US$142b - US$12b) (Based on the trailing twelve months to June 2024).
Therefore, Southern has an ROCE of 5.8%. 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 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 for free.
The Trend Of ROCE
In terms of Southern's historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 5.8% for the last five years, and the capital employed within the business has risen 25% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
What We Can Learn From Southern's ROCE
As we've seen above, Southern's returns on capital haven't increased but it is reinvesting in the business. Although the market must be expecting these trends to improve because the stock has gained 80% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Southern does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...
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.
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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.