Investors Could Be Concerned With Patel Engineering's (NSE:PATELENG) Returns On Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. On that note, looking into Patel Engineering (NSE:PATELENG), we weren't too upbeat about how things were going.

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. The formula for this calculation on Patel Engineering is:

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

0.052 = ₹2.4b ÷ (₹81b - ₹35b) (Based on the trailing twelve months to June 2021).

Thus, Patel Engineering has an ROCE of 5.2%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 11%.

View our latest analysis for Patel Engineering

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Patel Engineering, check out these free graphs here.

The Trend Of ROCE

In terms of Patel Engineering's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 7.9% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Patel Engineering to turn into a multi-bagger.

On a separate but related note, it's important to know that Patel Engineering has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. 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.

Our Take On 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. Unsurprisingly then, the stock has dived 78% over the last five years, so investors are recognizing these changes and don't like the company's prospects. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Patel Engineering (of which 1 is potentially serious!) that you should know about.

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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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.
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