Larsen & Toubro (NSE:LT) Shareholders Will Want The ROCE Trajectory To Continue

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Larsen & Toubro's (NSE:LT) returns on capital, so let's have a look.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Larsen & Toubro:

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

0.13 = ₹217b ÷ (₹3.3t - ₹1.6t) (Based on the trailing twelve months to June 2023).

So, Larsen & Toubro has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Construction industry average of 12%.

View our latest analysis for Larsen & Toubro

Above you can see how the current ROCE for Larsen & Toubro compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Larsen & Toubro.

What The Trend Of ROCE Can Tell Us

The trends we've noticed at Larsen & Toubro are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 13%. Basically the business is earning more per dollar of capital invested and in addition to that, 25% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

Another thing to note, Larsen & Toubro has a high ratio of current liabilities to total assets of 49%. 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

All in all, it's terrific to see that Larsen & Toubro is reaping the rewards from prior investments and is growing its capital base. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

Larsen & Toubro does have some risks, we noticed 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

While Larsen & Toubro 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.