Kalyani Forge (NSE:KALYANIFRG) Is Finding It Tricky To Allocate Its Capital

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Kalyani Forge (NSE:KALYANIFRG), so let's see why.

Understanding 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. Analysts use this formula to calculate it for Kalyani Forge:

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

0.091 = ₹103m ÷ (₹2.1b - ₹928m) (Based on the trailing twelve months to March 2023).

Thus, Kalyani Forge has an ROCE of 9.1%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 13%.

See our latest analysis for Kalyani Forge

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

The Trend Of ROCE

In terms of Kalyani Forge's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 12%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Kalyani Forge becoming one if things continue as they have.

On a side note, Kalyani Forge's current liabilities are still rather high at 45% of total assets. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Kalyani Forge's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 21% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Kalyani Forge (of which 1 doesn't sit too well with us!) that you should know about.

While Kalyani Forge isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.