The Returns On Capital At Ashok Leyland (NSE:ASHOKLEY) Don't Inspire Confidence

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. In light of that, when we looked at Ashok Leyland (NSE:ASHOKLEY) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Ashok Leyland is:

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

0.075 = ₹18b ÷ (₹414b - ₹174b) (Based on the trailing twelve months to September 2021).

Thus, Ashok Leyland has an ROCE of 7.5%. Ultimately, that's a low return and it under-performs the Machinery industry average of 15%.

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.

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

On the surface, the trend of ROCE at Ashok Leyland doesn't inspire confidence. Around five years ago the returns on capital were 17%, but since then they've fallen to 7.5%. 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.

On a separate but related note, it's important to know that Ashok Leyland has a current liabilities to total assets ratio of 42%, which we'd consider pretty high. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Ashok Leyland's ROCE

While returns have fallen for Ashok Leyland in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 54% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Ashok Leyland (of which 2 can't be ignored!) that you should 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.

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.