Capital Allocation Trends At Sterling Tools (NSE:STERTOOLS) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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 Sterling Tools (NSE:STERTOOLS) and its ROCE trend, we weren't exactly thrilled.

What is 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. To calculate this metric for Sterling Tools, this is the formula:

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

0.10 = ₹415m ÷ (₹5.2b - ₹1.2b) (Based on the trailing twelve months to December 2021).

Therefore, Sterling Tools has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Auto Components industry average of 13%.

Check out our latest analysis for Sterling Tools

Historical performance is a great place to start when researching a stock so above you can see the gauge for Sterling Tools' ROCE against it's prior returns. If you're interested in investigating Sterling Tools' past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Sterling Tools Tell Us?

In terms of Sterling Tools' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 30%, but since then they've fallen to 10%. 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. If these investments prove successful, this can bode very well for long term stock performance.

What We Can Learn From Sterling Tools' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Sterling Tools. However, despite the promising trends, the stock has fallen 17% over the last five years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you want to know some of the risks facing Sterling Tools we've found 4 warning signs (1 can't be ignored!) that you should be aware of before investing here.

While Sterling Tools may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.