Elgi Equipments (NSE:ELGIEQUIP) Knows How To Allocate Capital Effectively

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Speaking of which, we noticed some great changes in Elgi Equipments' (NSE:ELGIEQUIP) returns on capital, so let's have a look.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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 = ₹4.0b ÷ (₹25b - ₹10b) (Based on the trailing twelve months to September 2023).

Therefore, Elgi Equipments has an ROCE of 27%. In absolute terms that's a great return and it's even better than the Machinery industry average of 16%.

View 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 report on analyst forecasts for the company.

How Are Returns Trending?

Elgi Equipments is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 27%. Basically the business is earning more per dollar of capital invested and in addition to that, 94% more capital is being employed now too. So we're very much inspired by what we're seeing at Elgi Equipments thanks to its ability to profitably reinvest capital.

Another thing to note, Elgi Equipments has a high ratio of current liabilities to total assets of 41%. 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.

What We Can Learn From Elgi Equipments' ROCE

All in all, it's terrific to see that Elgi Equipments is reaping the rewards from prior investments and is growing its capital base. And a remarkable 353% 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.

Like most companies, Elgi Equipments does come with some risks, and we've found 1 warning sign that you should be aware of.

Elgi Equipments 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.

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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.