Returns On Capital At HEG (NSE:HEG) Paint A Concerning Picture

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 HEG (NSE:HEG), it didn't seem to tick all of these boxes.

Understanding 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 HEG, this is the formula:

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

0.14 = ₹5.6b ÷ (₹53b - ₹13b) (Based on the trailing twelve months to June 2022).

Therefore, HEG has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 13% generated by the Electrical industry.

Check out our latest analysis for HEG

Historical performance is a great place to start when researching a stock so above you can see the gauge for HEG's ROCE against it's prior returns. If you're interested in investigating HEG's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From HEG's ROCE Trend?

In terms of HEG's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 14% from 36% 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. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, HEG has decreased its current liabilities to 24% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

While returns have fallen for HEG in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These trends are starting to be recognized by investors since the stock has delivered a 11% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

On a final note, we found 2 warning signs for HEG (1 doesn't sit too well with us) you should be aware of.

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.

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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.