Lokesh Machines (NSE:LOKESHMACH) Will Be Hoping To Turn Its Returns On Capital Around

What underlying fundamental trends can indicate that a company might be in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Basically the company is earning less on its investments and it is also reducing its total assets. On that note, looking into Lokesh Machines (NSE:LOKESHMACH), we weren't too upbeat about how things were going.

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

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 Lokesh Machines, this is the formula:

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

0.026 = ₹42m ÷ (₹2.8b - ₹1.2b) (Based on the trailing twelve months to December 2020).

Therefore, Lokesh Machines has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 12%.

Check out our latest analysis for Lokesh Machines

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

What Can We Tell From Lokesh Machines' ROCE Trend?

We are a bit worried about the trend of returns on capital at Lokesh Machines. Unfortunately the returns on capital have diminished from the 10% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Lokesh Machines to turn into a multi-bagger.

On a separate but related note, it's important to know that Lokesh Machines has a current liabilities to total assets ratio of 41%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

In summary, it's unfortunate that Lokesh Machines is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 43% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 4 warning signs with Lokesh Machines (at least 2 which don't sit too well with us) , and understanding these would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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