What Do The Returns On Capital At PSP Projects (NSE:PSPPROJECT) Tell Us?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Looking at PSP Projects (NSE:PSPPROJECT), it does have a high ROCE right now, but lets see how returns are trending.

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 PSP Projects:

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

0.22 = ₹1.0b ÷ (₹8.9b - ₹4.2b) (Based on the trailing twelve months to September 2020).

Therefore, PSP Projects has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Construction industry average of 8.7%.

Check out our latest analysis for PSP Projects

Above you can see how the current ROCE for PSP Projects compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering PSP Projects here for free.

The Trend Of ROCE

In terms of PSP Projects' historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, four years ago it was 51%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, PSP Projects has done well to pay down its current liabilities to 47% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 47% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by PSP Projects' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 1.2% over the last three years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

If you want to know some of the risks facing PSP Projects we've found 2 warning signs (1 shouldn't be ignored!) that you should be aware of before investing here.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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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