HPL Electric & Power (NSE:HPL) Might Be Having Difficulty Using Its Capital Effectively

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. However, after briefly looking over the numbers, we don't think HPL Electric & Power (NSE:HPL) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on HPL Electric & Power is:

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

0.073 = ₹605m ÷ (₹16b - ₹7.4b) (Based on the trailing twelve months to December 2020).

So, HPL Electric & Power has an ROCE of 7.3%. Ultimately, that's a low return and it under-performs the Electrical industry average of 11%.

View our latest analysis for HPL Electric & Power

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

How Are Returns Trending?

In terms of HPL Electric & Power's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 25% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, HPL Electric & Power has done well to pay down its current liabilities to 47% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line On HPL Electric & Power's ROCE

In summary, we're somewhat concerned by HPL Electric & Power's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 39% from where it was three years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

HPL Electric & Power does have some risks, we noticed 4 warning signs (and 2 which shouldn't be ignored) we think you should know about.

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. 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.
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