The Returns On Capital At Blue Star (NSE:BLUESTARCO) Don't Inspire Confidence

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at Blue Star (NSE:BLUESTARCO) and its ROCE trend, we weren't exactly thrilled.

Understanding 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. The formula for this calculation on Blue Star is:

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

0.17 = ₹2.2b ÷ (₹33b - ₹20b) (Based on the trailing twelve months to September 2021).

So, Blue Star has an ROCE of 17%. That's a relatively normal return on capital, and it's around the 16% generated by the Building industry.

Check out our latest analysis for Blue Star

In the above chart we have measured Blue Star's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Blue Star's ROCE Trend?

On the surface, the trend of ROCE at Blue Star doesn't inspire confidence. To be more specific, ROCE has fallen from 21% 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 Blue Star has a current liabilities to total assets ratio of 61%, 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 Blue Star's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Blue Star is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 85% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

On a separate note, we've found 1 warning sign for Blue Star you'll probably want to know about.

While Blue Star 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.

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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.