Here's What's Concerning About Greaves Cotton's (NSE:GREAVESCOT) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Greaves Cotton (NSE:GREAVESCOT), 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. To calculate this metric for Greaves Cotton, this is the formula:

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

0.035 = ₹715m ÷ (₹27b - ₹6.7b) (Based on the trailing twelve months to December 2022).

So, Greaves Cotton has an ROCE of 3.5%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 16%.

View our latest analysis for Greaves Cotton

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'd like to look at how Greaves Cotton has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

SWOT Analysis for Greaves Cotton

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Greaves Cotton, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 3.5% from 21% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Greaves Cotton. These trends are starting to be recognized by investors since the stock has delivered a 15% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

If you want to know some of the risks facing Greaves Cotton we've found 2 warning signs (1 can't be ignored!) that you should be aware of before investing here.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.