What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Energy Recovery (NASDAQ:ERII) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Energy Recovery is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.06 = US$15m ÷ (US$263m - US$19m) (Based on the trailing twelve months to September 2024).
Therefore, Energy Recovery has an ROCE of 6.0%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 12%.
Above you can see how the current ROCE for Energy Recovery compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Energy Recovery .
So How Is Energy Recovery's ROCE Trending?
When we looked at the ROCE trend at Energy Recovery, we didn't gain much confidence. Around five years ago the returns on capital were 7.8%, but since then they've fallen to 6.0%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
The Bottom Line On Energy Recovery's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Energy Recovery. Furthermore the stock has climbed 54% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.
If you'd like to know about the risks facing Energy Recovery, we've discovered 2 warning signs that you should be aware of.
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.
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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.
