This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between Tata Consultancy Services Limited (NSE:TCS)’s return fundamentals and stock market performance.
Purchasing Tata Consultancy Services gives you an ownership stake in the company. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Thus, to understand how your money can grow by investing in Tata Consultancy Services, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).
Calculating Return On Capital Employed for TCS
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. Accordingly, before you invest you need to assess the capital returns that the company has produced with reference to a certain benchmark to ensure that you are confident in the business’ ability to grow your capital at a level that grants an investment over other companies. To determine Tata Consultancy Services’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). I have calculated Tata Consultancy Services’s ROCE for you below:
ROCE Calculation for TCS
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = ₹372.6b ÷ (₹1.0t – ₹225.5b) = 47%
TCS’s 47% ROCE means that for every ₹100 you invest, the company creates ₹46.9. This makes Tata Consultancy Services exceptionally profitable when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future and is able to either provide solid dividends or reinvestment opportunities, your capital will enlarge at a rapid rate over time.
A deeper look
Although Tata Consultancy Services is in a favourable position, you should know that this could change if the company is unable to maintain a strong ROCE above the benchmark, which will depend on the behaviour of the underlying variables (EBT and capital employed). Because of this, it is important to look beyond the final value of TCS’s ROCE and understand what is happening to the individual components. Looking at the past 3 year period shows us that TCS boosted investor return on capital employed from 44%. We can see that earnings have increased from ₹274.2b to ₹372.6b whilst the amount of capital employed also grew but by a proportionally lesser volume, which suggests the larger ROCE is due to a growth in earnings relative to capital requirements.
TCS’s investors have enjoyed an upward trend in ROCE and it is above a benchmark that makes the company a potentially attractive stock that can achieve a solid return on investment. This makes the company an attractive place to put your money, but ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. Without considering these fundamentals, you cannot be sure if this trend will continue or if you are getting a good deal for the future returns you are paying for. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for TCS’s future growth? Take a look at our free research report of analyst consensus for TCS’s outlook.
- Valuation: What is TCS worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether TCS is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.