Returns On Capital Signal Tricky Times Ahead For Kajaria Ceramics (NSE:KAJARIACER)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, while the ROCE is currently high for Kajaria Ceramics (NSE:KAJARIACER), we aren't jumping out of our chairs because returns are decreasing.

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 Kajaria Ceramics:

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

0.24 = ₹5.3b ÷ (₹27b - ₹4.9b) (Based on the trailing twelve months to September 2021).

Thus, Kajaria Ceramics has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Building industry average of 15%.

View our latest analysis for Kajaria Ceramics

In the above chart we have measured Kajaria Ceramics' 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 Kajaria Ceramics here for free.

What Can We Tell From Kajaria Ceramics' ROCE Trend?

On the surface, the trend of ROCE at Kajaria Ceramics doesn't inspire confidence. While it's comforting that the ROCE is high, five years ago it was 31%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Kajaria Ceramics has done well to pay down its current liabilities to 18% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

What We Can Learn From Kajaria Ceramics' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Kajaria Ceramics. And the stock has done incredibly well with a 171% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you're still interested in Kajaria Ceramics it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

Kajaria Ceramics is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.