HPL Electric & Power's (NSE:HPL) Returns Have Hit A Wall

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. In light of that, when we looked at HPL Electric & Power (NSE:HPL) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for HPL Electric & Power, this is the formula:

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

0.14 = ₹1.2b ÷ (₹17b - ₹8.2b) (Based on the trailing twelve months to June 2023).

So, HPL Electric & Power has an ROCE of 14%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Electrical industry average of 15%.

See our latest analysis for HPL Electric & Power

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 want to delve into the historical earnings, revenue and cash flow of HPL Electric & Power, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

There hasn't been much to report for HPL Electric & Power's returns and its level of capital employed because both metrics have been steady for the past five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect HPL Electric & Power to be a multi-bagger going forward.

Another thing to note, HPL Electric & Power has a high ratio of current liabilities to total assets of 48%. 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.

The Key Takeaway

In summary, HPL Electric & Power isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Yet to long term shareholders the stock has gifted them an incredible 251% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing: We've identified 4 warning signs with HPL Electric & Power (at least 3 which are potentially serious) , and understanding these would certainly be useful.

While HPL Electric & Power may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.