Powell Industries: A Compounding Machine with a 37% ROCE and a Path to Sustained Growth

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In the world of investing, one of the most coveted qualities in a company is its ability to compound wealth consistently over time. These “compounding machines” are companies that not only generate high returns on their invested capital but also reinvest those returns at similarly high rates. Powell Industries (NASDAQ:POWL) appears to be one such company, with a Return on Capital Employed (ROCE) of 37% for the trailing twelve months (TTM) ending in March 2025. This performance significantly outpaces the industry average of 11%, making Powell a standout in the electrical power distribution sector.

What is ROCE and Why Does It Matter?

ROCE is a financial metric that measures a company's profitability and capital efficiency. It is calculated as Earnings Before Interest and Tax (EBIT) divided by (Total Assets - Current Liabilities). For Powell Industries, this means that for every dollar of capital employed in its operations, it generates $0.37 in pre-tax profits. This is a remarkable figure, especially when compared to the industry average of 11%, which suggests that most companies in the sector are only generating $0.11 in pre-tax profits for every dollar of capital employed.

The significance of a high ROCE lies in its implications for compounding. When a company consistently generates high returns on its capital, it has the ability to reinvest those returns at similarly high rates, leading to exponential growth over time. This is the essence of a compounding machine.

A Five-Year Trend of Compounding at Powell Industries

Over the past five years, Powell Industries has demonstrated a consistent ability to generate strong returns on its capital:

• 2024 ROCE: 37.09%
• 2023 ROCE: 36.19%
• 2022 ROCE: 35.25%
• 2021 ROCE: 44.52%
• 2020 ROCE: 40.05%

These figures indicate that Powell has not only maintained a high ROCE but has also seen periods of significant improvement, such as in 2021 when its ROCE reached 44.52%. Even in the years where ROCE dipped slightly, such as 2022, the company remained well above industry benchmarks. This consistency is a key characteristic of a compounding machine.

The Power of Reinvestment

A compounding machine is not just about generating high returns; it's also about the ability to reinvest those returns effectively. Powell Industries has demonstrated this capability through its Return on Invested Capital (ROIC), which reached 36.56% for the quarter ending in March 2025. This ROIC is well above the company's cost of capital of 7.57%, indicating that the company is generating substantial value for its shareholders.

The company's ability to reinvest its capital effectively is further evidenced by its impressive earnings per share (EPS) growth. Over the past five years, Powell's EPS has grown at an average rate of 78.20% per year. In the most recent three years, this growth rate accelerated to 526.40% annually, indicating a period of rapid expansion and increasing profitability.

Competitive Advantages and Industry Position

Powell Industries has several competitive advantages that position it as a strong compounding machine:

1. Specialized Engineering Expertise: Powell focuses on custom-engineered solutions for complex capital investment projects in the oil and gas and electric utility industries. This specialization allows it to command premium pricing and maintain high margins.
2. Strong Order Backlog: The company has a robust backlog of $1.3 billion in orders, with visibility through 2027. This backlog provides stability and shields the company from short-term demand fluctuations.
3. Operational Efficiency: Powell has demonstrated strong operational efficiency, with its gross margin expanding by 530 basis points to 29.9% in Q2 2025. Management has expressed confidence in maintaining gross margins in the range of 26–27% through 2025.
4. Strategic Product Launches: The company has launched high-margin products such as IEC-compliant grounding switches, compact substation systems, and data center switchgear, which are tailored to high-growth markets like LNG infrastructure, battery energy storage systems (BESS), and digital infrastructure.
5. Valuation Advantage: Despite its strong growth, Powell is trading at a PEG ratio of 1.09, which is significantly lower than the broader electrical equipment sector's PEG ratio of 1.91. This suggests that the company is undervalued relative to its growth potential.

Implications for Investors

For investors seeking long-term compounding growth, Powell Industries presents an attractive opportunity. The company's ability to generate and reinvest capital at high rates of return has led to impressive stock performance, with the stock returning 842% to shareholders over the last five years. If Powell can maintain its current trends in ROCE and ROIC, it has the potential to continue delivering strong returns.

However, investors should also be aware of the company's increased reliance on short-term financing, as current liabilities now account for 42% of total assets. While this has contributed to the growth in ROCE, it also introduces some risk if the company is unable to manage its short-term obligations effectively.

Conclusion

Powell Industries (NASDAQ:POWL) has demonstrated the characteristics of a true compounding machine, with a ROCE of 37% and the ability to reinvest its capital effectively. The company's strong financial performance, competitive advantages, and strategic positioning in high-growth markets make it an attractive option for investors seeking long-term compounding growth. As the company continues to execute on its growth strategy and navigate the challenges of short-term financing, it has the potential to deliver continued value to its shareholders.