Some Investors May Be Worried About Hind Rectifiers' (NSE:HIRECT) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Hind Rectifiers (NSE:HIRECT), we don't think it's current trends fit the mold of a multi-bagger.

What Is 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. The formula for this calculation on Hind Rectifiers is:

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

0.035 = ₹46m ÷ (₹2.9b - ₹1.6b) (Based on the trailing twelve months to December 2022).

Therefore, Hind Rectifiers has an ROCE of 3.5%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 16%.

View our latest analysis for Hind Rectifiers

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're interested in investigating Hind Rectifiers' past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Hind Rectifiers' ROCE Trend?

On the surface, the trend of ROCE at Hind Rectifiers doesn't inspire confidence. Around five years ago the returns on capital were 7.1%, but since then they've fallen to 3.5%. However it looks like Hind Rectifiers might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a separate but related note, it's important to know that Hind Rectifiers has a current liabilities to total assets ratio of 55%, which we'd consider pretty high. 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.

What We Can Learn From Hind Rectifiers' ROCE

In summary, Hind Rectifiers is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 78% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing: We've identified 4 warning signs with Hind Rectifiers (at least 2 which don't sit too well with us) , and understanding them would certainly be useful.

While Hind Rectifiers 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.