Should You Be Impressed By CMI's (NSE:CMICABLES) Returns on Capital?

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at CMI (NSE:CMICABLES), it didn't seem to tick all of these boxes.

What is 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 CMI:

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

0.076 = ₹286m ÷ (₹7.0b - ₹3.2b) (Based on the trailing twelve months to June 2020).

Therefore, CMI has an ROCE of 7.6%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 9.8%.

Check out our latest analysis for CMI

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 CMI, check out these free graphs here.

So How Is CMI's ROCE Trending?

On the surface, the trend of ROCE at CMI doesn't inspire confidence. To be more specific, ROCE has fallen from 41% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. 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.

On a related note, CMI has decreased its current liabilities to 46% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 46% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for CMI have fallen, meanwhile the business is employing more capital than it was five years ago. Unsurprisingly then, the stock has dived 86% over the last three years, so investors are recognizing these changes and don't like the company's prospects. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

CMI does have some risks, we noticed 5 warning signs (and 3 which are a bit concerning) we think you should know about.

While CMI 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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