Elgi Equipments (NSE:ELGIEQUIP) Is Very Good At Capital Allocation

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. With that in mind, the ROCE of Elgi Equipments (NSE:ELGIEQUIP) looks great, so lets see what the trend can tell us.

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. The formula for this calculation on Elgi Equipments is:

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

0.27 = ₹4.2b ÷ (₹26b - ₹11b) (Based on the trailing twelve months to December 2023).

So, Elgi Equipments has an ROCE of 27%. That's a fantastic return and not only that, it outpaces the average of 18% earned by companies in a similar industry.

Check out our latest analysis for Elgi Equipments

In the above chart we have measured Elgi Equipments' 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 analyst report for Elgi Equipments .

What The Trend Of ROCE Can Tell Us

The trends we've noticed at Elgi Equipments are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 27%. The amount of capital employed has increased too, by 84%. So we're very much inspired by what we're seeing at Elgi Equipments thanks to its ability to profitably reinvest capital.

On a side note, Elgi Equipments' current liabilities are still rather high at 40% of total assets. 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 Key Takeaway

In summary, it's great to see that Elgi Equipments can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And a remarkable 439% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

If you want to continue researching Elgi Equipments, you might be interested to know about the 1 warning sign that our analysis has discovered.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.