Sona BLW Precision Forgings (NSE:SONACOMS) May Have Issues Allocating Its Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after investigating Sona BLW Precision Forgings (NSE:SONACOMS), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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. Analysts use this formula to calculate it for Sona BLW Precision Forgings:

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

0.19 = ₹4.1b ÷ (₹26b - ₹3.8b) (Based on the trailing twelve months to June 2022).

So, Sona BLW Precision Forgings has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 12% generated by the Auto Components industry.

Check out our latest analysis for Sona BLW Precision Forgings

In the above chart we have measured Sona BLW Precision Forgings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Sona BLW Precision Forgings here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Sona BLW Precision Forgings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 19% from 25% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Sona BLW Precision Forgings has decreased its current liabilities to 15% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Sona BLW Precision Forgings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Sona BLW Precision Forgings is reinvesting for growth and has higher sales as a result. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you're still interested in Sona BLW Precision Forgings it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

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.