When researching a stock for investment, what can tell us that the company is in decline? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at ABB Power Products and Systems India (NSE:POWERINDIA), so let's see why.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on ABB Power Products and Systems India is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = ₹1.8b ÷ (₹32b - ₹22b) (Based on the trailing twelve months to September 2021).
Thus, ABB Power Products and Systems India has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 10% generated by the Electrical industry.
In the above chart we have measured ABB Power Products and Systems India's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is ABB Power Products and Systems India's ROCE Trending?
We are a bit worried about the trend of returns on capital at ABB Power Products and Systems India. To be more specific, the ROCE was 33% one year ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 ABB Power Products and Systems India becoming one if things continue as they have.
On a separate but related note, it's important to know that ABB Power Products and Systems India has a current liabilities to total assets ratio of 69%, 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.
The Bottom Line
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Since the stock has skyrocketed 147% over the last year, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you want to continue researching ABB Power Products and Systems India, you might be interested to know about the 1 warning sign that our analysis has discovered.
While ABB Power Products and Systems India 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.
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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