There are a few key trends to look for if we want to identify the next multi-bagger. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Energy Recovery (NASDAQ:ERII), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Energy Recovery:

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

0.082 = US$19m ÷ (US$253m - US$21m) (Based on the trailing twelve months to December 2023).

Therefore, Energy Recovery has an ROCE of 8.2%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 13%.

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're interested, you can view the analysts predictions in our free analyst report for Energy Recovery .

What Can We Tell From Energy Recovery's ROCE Trend?

There are better returns on capital out there than what we're seeing at Energy Recovery. Over the past five years, ROCE has remained relatively flat at around 8.2% and the business has deployed 52% more capital into its operations. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

The Bottom Line On Energy Recovery's ROCE

As we've seen above, Energy Recovery's returns on capital haven't increased but it is reinvesting in the business. Since the stock has gained an impressive 58% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing, we've spotted 1 warning sign facing Energy Recovery that you might find interesting.

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.