Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 Severn Trent (LON:SVT) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Severn Trent:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.048 = UK£496m ÷ (UK£11b - UK£958m) (Based on the trailing twelve months to September 2021).

So, Severn Trent has an ROCE of 4.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 4.6%.

See our latest analysis for Severn Trent

In the above chart we have measured Severn Trent's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Severn Trent.

What Does the ROCE Trend For Severn Trent Tell Us?

In terms of Severn Trent's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 6.4% over the last five years. However it looks like Severn Trent might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

The Key Takeaway

To conclude, we've found that Severn Trent is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 50% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

On a final note, we found 3 warning signs for Severn Trent (1 is a bit concerning) 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.