Capital Allocation Trends At Ashok Leyland (NSE:ASHOKLEY) Aren't Ideal

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. 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 Ashok Leyland (NSE:ASHOKLEY) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

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

0.06 = ₹14b ÷ (₹376b - ₹149b) (Based on the trailing twelve months to December 2020).

Thus, Ashok Leyland has an ROCE of 6.0%. Ultimately, that's a low return and it under-performs the Machinery industry average of 11%.

Check out our latest analysis for Ashok Leyland

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 Ashok Leyland, check out these free graphs here.

How Are Returns Trending?

When we looked at the ROCE trend at Ashok Leyland, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 6.0% from 16% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

The Bottom Line On Ashok Leyland's ROCE

We're a bit apprehensive about Ashok Leyland because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Despite the concerning underlying trends, the stock has actually gained 22% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

On a separate note, we've found 2 warning signs for Ashok Leyland you'll probably want to know about.

While Ashok Leyland isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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