Be Wary Of Ashok Leyland (NSE:ASHOKLEY) And Its Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. However, after briefly looking over the numbers, we don't think Ashok Leyland (NSE:ASHOKLEY) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for Ashok Leyland:

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

0.15 = ₹49b ÷ (₹547b - ₹225b) (Based on the trailing twelve months to June 2023).

So, Ashok Leyland has an ROCE of 15%. That's a relatively normal return on capital, and it's around the 17% generated by the Machinery industry.

See our latest analysis for Ashok Leyland

In the above chart we have measured Ashok Leyland'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 Ashok Leyland here for free.

What Can We Tell From Ashok Leyland's ROCE Trend?

When we looked at the ROCE trend at Ashok Leyland, we didn't gain much confidence. To be more specific, ROCE has fallen from 19% over the last five years. 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.

Another thing to note, Ashok Leyland has a high ratio of current liabilities to total assets of 41%. 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.

Our Take On Ashok Leyland's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Ashok Leyland. And the stock has followed suit returning a meaningful 54% to shareholders over the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Ashok Leyland does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

While Ashok Leyland 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.