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

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Setco Automotive (NSE:SETCO) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

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)

0.13 = ₹526m ÷ (₹5.7b - ₹1.6b) (Based on the trailing twelve months to September 2024).

So, Setco Automotive has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Auto Components industry average of 14%.

View 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 , check out these free graphs detailing revenue and cash flow performance of Setco Automotive.

How Are Returns Trending?

On the surface, the trend of ROCE at Setco Automotive doesn't inspire confidence. Around five years ago the returns on capital were 25%, but since then they've fallen to 13%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Setco Automotive has done well to pay down its current liabilities to 29% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Setco Automotive's ROCE

While returns have fallen for Setco Automotive in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 50% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Setco Automotive does come with some risks though, we found 4 warning signs in our investment analysis, and 2 of those are concerning...

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.