If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Motherson Sumi Systems (NSE:MOTHERSUMI), it didn't seem to tick all of these boxes.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Motherson Sumi Systems is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.093 = ₹25b ÷ (₹474b - ₹200b) (Based on the trailing twelve months to December 2021).
Thus, Motherson Sumi Systems has an ROCE of 9.3%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 13%.
Above you can see how the current ROCE for Motherson Sumi Systems 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.
So How Is Motherson Sumi Systems' ROCE Trending?
When we looked at the ROCE trend at Motherson Sumi Systems, we didn't gain much confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 9.3%. 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.
Another thing to note, Motherson Sumi Systems has a high ratio of current liabilities to total assets of 42%. 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
Bringing it all together, while we're somewhat encouraged by Motherson Sumi Systems' reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 15% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
Motherson Sumi Systems does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is potentially serious...
While Motherson Sumi Systems 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.