There Are Reasons To Feel Uneasy About Bharat Forge's (NSE:BHARATFORG) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Bharat Forge (NSE:BHARATFORG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

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. To calculate this metric for Bharat Forge, this is the formula:

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

0.12 = ₹12b ÷ (₹184b - ₹83b) (Based on the trailing twelve months to June 2023).

Thus, Bharat Forge has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Auto Components industry average of 14%.

Check out our latest analysis for Bharat Forge

Above you can see how the current ROCE for Bharat Forge compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Bharat Forge doesn't inspire confidence. To be more specific, ROCE has fallen from 22% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a separate but related note, it's important to know that Bharat Forge has a current liabilities to total assets ratio of 45%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that Bharat Forge is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 74% to shareholders over the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Bharat Forge does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is concerning...

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.

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

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.