If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at ALLETE (NYSE:ALE), it didn't seem to tick all of these boxes.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for ALLETE:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.028 = US$170m ÷ (US$6.6b - US$557m) (Based on the trailing twelve months to March 2022).
So, ALLETE has an ROCE of 2.8%. Ultimately, that's a low return and it under-performs the Electric Utilities industry average of 4.8%.
Above you can see how the current ROCE for ALLETE 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 report on analyst forecasts for the company.
What Does the ROCE Trend For ALLETE Tell Us?
On the surface, the trend of ROCE at ALLETE doesn't inspire confidence. Around five years ago the returns on capital were 4.8%, but since then they've fallen to 2.8%. 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.
What We Can Learn From ALLETE'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 ALLETE. However, total returns to shareholders over the last five years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
If you'd like to know more about ALLETE, we've spotted 3 warning signs, and 1 of them is a bit unpleasant.
While ALLETE isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.