Should We Be Excited About The Trends Of Returns At Reliance Power (NSE:RPOWER)?

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. In light of that, when we looked at Reliance Power (NSE:RPOWER) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on Reliance Power is:

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

0.061 = ₹23b ÷ (₹538b - ₹169b) (Based on the trailing twelve months to September 2020).

So, Reliance Power has an ROCE of 6.1%. In absolute terms, that's a low return but it's around the Renewable Energy industry average of 6.6%.

See our latest analysis for Reliance Power

Historical performance is a great place to start when researching a stock so above you can see the gauge for Reliance Power's ROCE against it's prior returns. If you're interested in investigating Reliance Power's past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

Over the past five years, Reliance Power's ROCE has remained relatively flat while the business is using 31% less capital than before. When a company effectively decreases its assets base, it's not usually a sign to be optimistic on that company. Not only that, but the low returns on this capital mentioned earlier would leave most investors unimpressed.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 31% of total assets, this reported ROCE would probably be less than6.1% because total capital employed would be higher.The 6.1% ROCE could be even lower if current liabilities weren't 31% of total assets, because the the formula would show a larger base of total capital employed. So while current liabilities isn't high right now, keep an eye out in case it increases further, because this can introduce some elements of risk.

Our Take On Reliance Power's ROCE

In summary, Reliance Power isn't reinvesting funds back into the business and returns aren't growing. It seems that investors have little hope of these trends getting any better and that may have partly contributed to the stock collapsing 94% in the last five years. Therefore based on the analysis done in this article, we don't think Reliance Power has the makings of a multi-bagger.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Reliance Power (of which 1 doesn't sit too well with us!) that you should know about.

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.

If you decide to trade Reliance Power, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.