The Returns On Capital At Sundaram-Clayton (NSE:SUNCLAYLTD) Don't Inspire Confidence

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Sundaram-Clayton (NSE:SUNCLAYLTD) and its ROCE trend, we weren't exactly thrilled.

What is 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. The formula for this calculation on Sundaram-Clayton is:

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

0.15 = ₹17b ÷ (₹234b - ₹115b) (Based on the trailing twelve months to March 2021).

Thus, Sundaram-Clayton has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Auto Components industry average of 8.9% it's much better.

View our latest analysis for Sundaram-Clayton

Historical performance is a great place to start when researching a stock so above you can see the gauge for Sundaram-Clayton's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Sundaram-Clayton, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Sundaram-Clayton doesn't inspire confidence. To be more specific, ROCE has fallen from 21% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Sundaram-Clayton's current liabilities are still rather high at 49% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Sundaram-Clayton's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 90% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

Sundaram-Clayton does have some risks, we noticed 3 warning signs (and 2 which are potentially serious) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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