What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Having said that, from a first glance at Pinnacle West Capital (NYSE:PNW) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Pinnacle West Capital, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.045 = US$921m ÷ (US$22b - US$1.6b) (Based on the trailing twelve months to March 2022).
Thus, Pinnacle West Capital has an ROCE of 4.5%. On its own, that's a low figure but it's around the 4.8% average generated by the Electric Utilities industry.
In the above chart we have measured Pinnacle West Capital'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 Pinnacle West Capital here for free.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Pinnacle West Capital doesn't inspire confidence. To be more specific, ROCE has fallen from 5.8% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
Our Take On Pinnacle West Capital's ROCE
Bringing it all together, while we're somewhat encouraged by Pinnacle West Capital's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 4.0% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.
On a final note, we found 3 warning signs for Pinnacle West Capital (1 is concerning) you should be aware of.
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.