Should You Be Worried About Patel Engineering's (NSE:PATELENG) Returns On Capital?

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. And from a first read, things don't look too good at Patel Engineering (NSE:PATELENG), so let's see why.

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. To calculate this metric for Patel Engineering, this is the formula:

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

0.012 = ₹480m ÷ (₹80b - ₹40b) (Based on the trailing twelve months to September 2020).

Thus, Patel Engineering has an ROCE of 1.2%. Ultimately, that's a low return and it under-performs the Construction industry average of 9.9%.

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.

What Can We Tell From Patel Engineering's ROCE Trend?

There is reason to be cautious about Patel Engineering, given the returns are trending downwards. About five years ago, returns on capital were 8.5%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. 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 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

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. We expect this has contributed to the stock plummeting 76% during the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing, we've spotted 3 warning signs facing Patel Engineering that you might find interesting.

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.

When trading Patel Engineering or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St 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. Simply Wall St has no position in any stocks mentioned.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.