Be Wary Of Amara Raja Batteries (NSE:AMARAJABAT) And Its Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Amara Raja Batteries (NSE:AMARAJABAT), it didn't seem to tick all of these boxes.

Understanding 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. To calculate this metric for Amara Raja Batteries, this is the formula:

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

0.20 = ₹8.7b ÷ (₹58b - ₹13b) (Based on the trailing twelve months to June 2021).

So, Amara Raja Batteries has an ROCE of 20%. On its own, that's a standard return, however it's much better than the 11% generated by the Electrical industry.

View our latest analysis for Amara Raja Batteries

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

What Can We Tell From Amara Raja Batteries' ROCE Trend?

In terms of Amara Raja Batteries' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 30%, but since then they've fallen to 20%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

What We Can Learn From Amara Raja Batteries' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Amara Raja Batteries is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 23% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

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

While Amara Raja Batteries 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.

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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