Hindustan Aeronautics (NSE:HAL) Is Experiencing Growth In Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Hindustan Aeronautics' (NSE:HAL) 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. To calculate this metric for Hindustan Aeronautics, this is the formula:

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

0.12 = ₹40b ÷ (₹584b - ₹250b) (Based on the trailing twelve months to June 2022).

Thus, Hindustan Aeronautics has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 14% generated by the Aerospace & Defense industry.

Our analysis indicates that HAL is potentially undervalued!

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hindustan Aeronautics' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Hindustan Aeronautics, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

The trends we've noticed at Hindustan Aeronautics are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 12%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 29%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

Another thing to note, Hindustan Aeronautics has a high ratio of current liabilities to total assets of 43%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Hindustan Aeronautics' ROCE

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Hindustan Aeronautics has. And a remarkable 269% total return over the last three years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if Hindustan Aeronautics can keep these trends up, it could have a bright future ahead.

Hindustan Aeronautics does have some risks though, and we've spotted 1 warning sign for Hindustan Aeronautics that you might be interested in.

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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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.