Here's What's Concerning About Tata Motors' (NSE:TATAMTRDVR) Returns On Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at Tata Motors (NSE:TATAMTRDVR), so let's see why.

Understanding Return On Capital Employed (ROCE)

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

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

0.07 = ₹129b ÷ (₹3.4t - ₹1.6t) (Based on the trailing twelve months to June 2021).

Therefore, Tata Motors has an ROCE of 7.0%. Ultimately, that's a low return and it under-performs the Auto industry average of 9.7%.

View our latest analysis for Tata Motors

In the above chart we have measured Tata Motors' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Tata Motors.

What Can We Tell From Tata Motors' ROCE Trend?

In terms of Tata Motors' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 12%, however they're now substantially lower than that as we saw above. 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 side note, Tata Motors' current liabilities are still rather high at 46% 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.

In Conclusion...

In summary, it's unfortunate that Tata Motors is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 58% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Tata Motors does have some risks though, and we've spotted 1 warning sign for Tata Motors that you might be interested in.

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.
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