Capital Allocation Trends At Patel Engineering (NSE:PATELENG) Aren't Ideal

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. So after we looked into Patel Engineering (NSE:PATELENG), the trends above didn't look too great.

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

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 Patel Engineering:

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

0.0058 = ₹232m ÷ (₹80b - ₹40b) (Based on the trailing twelve months to December 2020).

Thus, Patel Engineering has an ROCE of 0.6%. Ultimately, that's a low return and it under-performs the Construction industry average of 9.3%.

See our latest analysis for Patel Engineering

Historical performance is a great place to start when researching a stock so above you can see the gauge for Patel Engineering's ROCE against it's prior returns. If you're interested in investigating Patel Engineering's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Patel Engineering Tell Us?

In terms of Patel Engineering's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 8.2% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Patel Engineering becoming one if things continue as they have.

On a side note, Patel Engineering's current liabilities are still rather high at 50% of total assets. 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.

What We Can Learn From Patel Engineering's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 65% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Like most companies, Patel Engineering does come with some risks, and we've found 2 warning signs that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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