Tata Motors (NSE:TATAMOTORS) Could Be Struggling To Allocate Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within Tata Motors (NSE:TATAMOTORS), we weren't too hopeful.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Tata Motors:

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

0.035 = ₹63b ÷ (₹3.1t - ₹1.3t) (Based on the trailing twelve months to December 2021).

Thus, Tata Motors has an ROCE of 3.5%. In absolute terms, that's a low return and it also under-performs the Auto industry average of 15%.

See our latest analysis for Tata Motors

Above you can see how the current ROCE for Tata Motors compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Tata Motors.

What The Trend Of ROCE Can Tell Us

In terms of Tata Motors' historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 9.9% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Tata Motors becoming one if things continue as they have.

On a separate but related note, it's important to know that Tata Motors has a current liabilities to total assets ratio of 42%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Tata Motors' ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. And long term shareholders have watched their investments stay flat over the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

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

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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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.