Here's What's Concerning About Setco Automotive's (NSE:SETCO) Returns On Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after we looked into Setco Automotive (NSE:SETCO), the trends above didn't look too great.

Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Setco Automotive, this is the formula:

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

0.017 = ₹63m ÷ (₹5.7b - ₹2.1b) (Based on the trailing twelve months to March 2023).

So, Setco Automotive has an ROCE of 1.7%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 14%.

Check out our latest analysis for Setco Automotive

Historical performance is a great place to start when researching a stock so above you can see the gauge for Setco Automotive's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Setco Automotive, check out these free graphs here.

What Can We Tell From Setco Automotive's ROCE Trend?

We are a bit worried about the trend of returns on capital at Setco Automotive. Unfortunately the returns on capital have diminished from the 8.0% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Setco Automotive becoming one if things continue as they have.

On a side note, Setco Automotive has done well to pay down its current liabilities to 36% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

In summary, it's unfortunate that Setco Automotive is generating lower returns from the same amount of capital. This could explain why the stock has sunk a total of 84% in the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to know some of the risks facing Setco Automotive we've found 4 warning signs (2 are significant!) that you should be aware of before investing here.

While Setco Automotive 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.