This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in Lakshmi Machine Works Limited (NSE:LAXMIMACH).
If you purchase a LAXMIMACH share you are effectively becoming a partner with many other shareholders. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. Your return is tied to LAXMIMACH’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. Therefore, looking at how efficiently Lakshmi Machine Works is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
What is Return on Capital Employed (ROCE)?
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could've received, which is dependent on the gap between the return on capital you could've achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. We'll look at Lakshmi Machine Works’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. I have calculated Lakshmi Machine Works’s ROCE for you below:
ROCE Calculation for LAXMIMACH
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets - Current Liabilities)
∴ ROCE = ₹3.0b ÷ (₹26b - ₹7.9b) = 11%
LAXMIMACH’s 11% ROCE means that for every ₹100 you invest, the company creates ₹11.2. Comparing this to a healthy 15% benchmark shows Lakshmi Machine Works is currently unable to return a desired amount to owners for the use of their capital, which isn't favourable for investors who have forgone other potentially solid companies.
Why is this the case?
The underperforming ROCE is not ideal for Lakshmi Machine Works investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, LAXMIMACH's ROCE may increase, in which case your portfolio could benefit from holding the company. Therefore, investors need to understand the trend of the inputs in the formula above, so that they can see if there is an opportunity to invest. Three years ago, LAXMIMACH’s ROCE was 15%, which means the company's capital returns have worsened. The movement in the earnings variable over this time shows a fall from ₹3.1b to ₹3.0b whilst capital employed has increased due to an increase in total assets and a smaller reliance on current liabilities (less borrowing to fund operations) , which means the company's ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.
Lakshmi Machine Works’s ROCE has decreased in the recent past and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. But don't forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like the management team and valuation. Lakshmi Machine Works's fundamentals can be explored with the links I've provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for Lakshmi Machine Works's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Valuation: What is LAXMIMACH worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether LAXMIMACH is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.
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Simply Wall St has no position in any of the companies mentioned. This article 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.
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