If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Having said that, from a first glance at Finolex Cables (NSE:FINCABLES) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Finolex Cables is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.092 = ₹3.0b ÷ (₹35b - ₹2.9b) (Based on the trailing twelve months to December 2020).
Therefore, Finolex Cables has an ROCE of 9.2%. On its own, that's a low figure but it's around the 11% average generated by the Electrical industry.
Above you can see how the current ROCE for Finolex Cables compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Finolex Cables here for free.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Finolex Cables doesn't inspire confidence. Over the last five years, returns on capital have decreased to 9.2% from 17% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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.
The Bottom Line
In summary, we're somewhat concerned by Finolex Cables' diminishing returns on increasing amounts of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 50% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you're still interested in Finolex Cables it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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