Kalyani Forge's (NSE:KALYANIFRG) Returns On Capital Not Reflecting Well On The Business

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. 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)

0.044 = ₹49m ÷ (₹2.0b - ₹916m) (Based on the trailing twelve months to September 2022).

So, Kalyani Forge has an ROCE of 4.4%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 13%.

Check out our latest analysis for Kalyani Forge

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're interested in investigating Kalyani Forge's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Kalyani Forge Tell Us?

There is reason to be cautious about Kalyani Forge, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 8.3% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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.

Another thing to note, Kalyani Forge has a high ratio of current liabilities to total assets of 45%. 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.

In Conclusion...

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 35% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One final note, you should learn about the 5 warning signs we've spotted with Kalyani Forge (including 1 which doesn't sit too well with us) .

While Kalyani Forge may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.