AIA Engineering (NSE:AIAENG) May Have Issues Allocating Its Capital

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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think AIA Engineering (NSE:AIAENG) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for AIA Engineering:

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

0.15 = ₹7.1b ÷ (₹51b - ₹3.0b) (Based on the trailing twelve months to June 2022).

Therefore, AIA Engineering has an ROCE of 15%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Machinery industry average of 14%.

Check out the opportunities and risks within the IN Machinery industry.

In the above chart we have measured AIA Engineering's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering AIA Engineering here for free.

What Does the ROCE Trend For AIA Engineering Tell Us?

When we looked at the ROCE trend at AIA Engineering, we didn't gain much confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 15%. 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.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that AIA Engineering is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 103% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

One more thing, we've spotted 1 warning sign facing AIA Engineering that you might find interesting.

While AIA Engineering 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.