Should We Be Excited About The Trends Of Returns At Sterling Tools (NSE:STERTOOLS)?

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Sterling Tools (NSE:STERTOOLS) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Sterling Tools:

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

0.032 = ₹125m ÷ (₹4.4b - ₹549m) (Based on the trailing twelve months to June 2020).

Therefore, Sterling Tools has an ROCE of 3.2%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 5.8%.

See our latest analysis for Sterling Tools

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Sterling Tools, check out these free graphs here.

So How Is Sterling Tools' ROCE Trending?

In terms of Sterling Tools' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 3.2% from 24% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Sterling Tools has done well to pay down its current liabilities to 12% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Sterling Tools have fallen, meanwhile the business is employing more capital than it was five years ago. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 180%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Like most companies, Sterling Tools does come with some risks, and we've found 3 warning signs that you should be aware of.

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. 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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