Returns On Capital At Rico Auto Industries (NSE:RICOAUTO) Have Hit The Brakes

What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Rico Auto Industries (NSE:RICOAUTO) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Rico Auto Industries, this is the formula:

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

0.093 = ₹810m ÷ (₹18b - ₹9.2b) (Based on the trailing twelve months to June 2022).

So, Rico Auto Industries 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%.

Check out our latest analysis for Rico Auto Industries

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 Rico Auto Industries' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

The returns on capital haven't changed much for Rico Auto Industries in recent years. The company has consistently earned 9.3% for the last five years, and the capital employed within the business has risen 38% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 51% of total assets, this reported ROCE would probably be less than9.3% because total capital employed would be higher.The 9.3% ROCE could be even lower if current liabilities weren't 51% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.

Our Take On Rico Auto Industries' ROCE

In conclusion, Rico Auto Industries has been investing more capital into the business, but returns on that capital haven't increased. And in the last five years, the stock has given away 27% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Rico Auto Industries has the makings of a multi-bagger.

One more thing: We've identified 4 warning signs with Rico Auto Industries (at least 2 which are concerning) , and understanding them would certainly be useful.

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.

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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.