Returns At Elgi Equipments (NSE:ELGIEQUIP) Appear To Be Weighed Down

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So, when we ran our eye over Elgi Equipments' (NSE:ELGIEQUIP) trend of ROCE, we liked what we saw.

Return On Capital Employed (ROCE): What is it?

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 Elgi Equipments:

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

0.15 = ₹1.6b ÷ (₹19b - ₹8.4b) (Based on the trailing twelve months to September 2021).

Thus, Elgi Equipments has an ROCE of 15%. By itself that's a normal return on capital and it's in line with the industry's average returns of 15%.

See 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'd like, you can check out the forecasts from the analysts covering Elgi Equipments here for free.

How Are Returns Trending?

While the current returns on capital are decent, they haven't changed much. Over the past five years, ROCE has remained relatively flat at around 15% and the business has deployed 46% more capital into its operations. 15% is a pretty standard return, and it provides some comfort knowing that Elgi Equipments has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 45% of total assets, this reported ROCE would probably be less than15% because total capital employed would be higher.The 15% ROCE could be even lower if current liabilities weren't 45% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

Our Take On Elgi Equipments' ROCE

To sum it up, Elgi Equipments has simply been reinvesting capital steadily, at those decent rates of return. And the stock has done incredibly well with a 305% return over the last five years, so long term investors are no doubt ecstatic with that result. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

Like most companies, Elgi Equipments does come with some risks, and we've found 2 warning signs that you should be aware of.

While Elgi Equipments isn't earning the highest return, check out this free list of companies that are 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.