There Are Reasons To Feel Uneasy About Jamna Auto Industries' (NSE:JAMNAAUTO) 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Looking at Jamna Auto Industries (NSE:JAMNAAUTO), it does have a high ROCE right now, but lets see how returns are trending.

Understanding Return On Capital Employed (ROCE)

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. Analysts use this formula to calculate it for Jamna Auto Industries:

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

0.31 = ₹2.7b ÷ (₹12b - ₹3.3b) (Based on the trailing twelve months to December 2023).

So, Jamna Auto Industries has an ROCE of 31%. In absolute terms that's a great return and it's even better than the Machinery industry average of 18%.

See our latest analysis for Jamna Auto Industries

In the above chart we have measured Jamna Auto Industries' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Jamna Auto Industries for free.

The Trend Of ROCE

In terms of Jamna Auto Industries' historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 47% where it was five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Jamna Auto Industries has decreased its current liabilities to 27% 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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Jamna Auto Industries' reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 188% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing to note, we've identified 1 warning sign with Jamna Auto Industries and understanding this should be part of your investment process.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.