Some Investors May Be Worried About Wheels India's (NSE:WHEELS) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Having said that, from a first glance at Wheels India (NSE:WHEELS) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Wheels India, this is the formula:

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

0.023 = ₹225m ÷ (₹20b - ₹10b) (Based on the trailing twelve months to December 2020).

Therefore, Wheels India has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 8.9%.

See our latest analysis for Wheels India

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Wheels India, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Wheels India, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 2.3% from 16% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Wheels India's current liabilities are still rather high at 51% 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 Key Takeaway

We're a bit apprehensive about Wheels India because despite more capital being deployed in the business, returns on that capital and sales have both fallen. In spite of that, the stock has delivered a 10% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

On a final note, we found 3 warning signs for Wheels India (2 can't be ignored) you should be aware of.

While Wheels India 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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