Setco Automotive (NSE:SETCO) May Have Issues Allocating Its Capital

What financial metrics can indicate to us that a company is maturing or even in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at Setco Automotive (NSE:SETCO), 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. The formula for this calculation on Setco Automotive is:

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

0.0013 = ₹4.8m ÷ (₹5.7b - ₹2.1b) (Based on the trailing twelve months to June 2023).

So, Setco Automotive has an ROCE of 0.1%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 14%.

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

What Does the ROCE Trend For Setco Automotive Tell Us?

We are a bit worried about the trend of returns on capital at Setco Automotive. Unfortunately the returns on capital have diminished from the 11% 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. If these trends continue, we wouldn't expect Setco Automotive to turn into a multi-bagger.

On a side note, Setco Automotive has done well to pay down its current liabilities to 36% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Setco Automotive's ROCE

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 76% in the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Setco Automotive does have some risks, we noticed 3 warning signs (and 2 which are a bit concerning) we think you should know about.

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.