Sterling Tools (NSE:STERTOOLS) Will Want To Turn Around Its Return Trends

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Sterling Tools (NSE:STERTOOLS), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Sterling Tools:

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).

So, Sterling Tools has an ROCE of 10%. That's a relatively normal return on capital, and it's around the 13% generated by the Auto Components industry.

View 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 The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Sterling Tools doesn't inspire confidence. 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.

Our Take On Sterling Tools' ROCE

While returns have fallen for Sterling Tools in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And there could be an opportunity here if other metrics look good too, because the stock has declined 54% in the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Sterling Tools does have some risks, we noticed 4 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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.