What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we’d like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we’ve noticed some promising trends at Energy Recovery (NASDAQ:ERII) so let’s look a bit deeper.
Understanding 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 Energy Recovery:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.16 = US$28m ÷ (US$186m – US$11m) (Based on the trailing twelve months to June 2020).
Therefore, Energy Recovery has an ROCE of 16%. On its own, that’s a standard return, however it’s much better than the 9.2% generated by the Machinery industry.
Check out our latest analysis for Energy Recovery
In the above chart we have measured Energy Recovery’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 Energy Recovery here for free.
The Trend Of ROCE
We’re delighted to see that Energy Recovery is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 16% on its capital. Not only that, but the company is utilizing 170% more capital than before, but that’s to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
Our Take On Energy Recovery’s ROCE
Overall, Energy Recovery gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And with the stock having performed exceptionally well over the last five years, these trends are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.
If you’d like to know about the risks facing Energy Recovery, we’ve discovered 2 warning signs that you should be aware of.
While Energy Recovery may not currently earn the highest returns, we’ve compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
This article by Simply Wall St is general in nature. 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.
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