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

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. 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)

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 Ashok Leyland:

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

0.13 = ₹35b ÷ (₹456b - ₹199b) (Based on the trailing twelve months to December 2022).

Therefore, Ashok Leyland has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Machinery industry average of 16%.

View 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.

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

On the surface, the trend of ROCE at Ashok Leyland doesn't inspire 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.

On a separate but related note, it's important to know that Ashok Leyland has a current liabilities to total assets ratio of 44%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Ashok Leyland's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Ashok Leyland is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 19% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

On a separate note, we've found 3 warning signs for Ashok Leyland you'll probably want to know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.