Blue Star (NSE:BLUESTARCO) Could Be Struggling To Allocate Capital

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. 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. Having said that, while the ROCE is currently high for Blue Star (NSE:BLUESTARCO), we aren't jumping out of our chairs because returns are decreasing.

What Is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Blue Star:

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

0.21 = ₹5.7b ÷ (₹66b - ₹39b) (Based on the trailing twelve months to March 2024).

Therefore, Blue Star has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Building industry average of 16%.

View our latest analysis for Blue Star

Above you can see how the current ROCE for Blue Star compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Blue Star .

So How Is Blue Star's ROCE Trending?

When we looked at the ROCE trend at Blue Star, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 32%. 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 related note, Blue Star has decreased its current liabilities to 59% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line On Blue Star'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 Blue Star. And long term investors must be optimistic going forward because the stock has returned a huge 292% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you want to know some of the risks facing Blue Star we've found 3 warning signs (1 can't be ignored!) that you should be aware of before investing here.

Blue Star is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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.