What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we’ll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company’s 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. In light of that, when we looked at Clearway Energy (NYSE:CWEN.A) and its ROCE trend, we weren’t exactly thrilled.
For those that aren’t sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Clearway Energy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.017 = US$228m ÷ (US$14b – US$661m) (Based on the trailing twelve months to September 2024).
Therefore, Clearway Energy has an ROCE of 1.7%. In absolute terms, that’s a low return and it also under-performs the Renewable Energy industry average of 3.6%.
View our latest analysis for Clearway Energy
In the above chart we have measured Clearway Energy’s prior ROCE against its prior performance, but the future is arguably more important. If you’re interested, you can view the analysts predictions in our free analyst report for Clearway Energy .
On the surface, the trend of ROCE at Clearway Energy doesn’t inspire confidence. Around five years ago the returns on capital were 4.9%, but since then they’ve fallen to 1.7%. Meanwhile, the business is utilizing more capital but this hasn’t moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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.
On a related note, Clearway Energy has decreased its current liabilities to 4.6% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it’s own money, you could argue this has made the business less efficient at generating ROCE.
Bringing it all together, while we’re somewhat encouraged by Clearway Energy’s reinvestment in its own business, we’re aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 65% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn’t high.
Clearway Energy does have some risks, we noticed 3 warning signs (and 1 which is a bit concerning) we think you should know about.
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.
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