Returns On Capital Are Showing Encouraging Signs At Shanthi Gears (NSE:SHANTIGEAR)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at Shanthi Gears (NSE:SHANTIGEAR) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

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. Analysts use this formula to calculate it for Shanthi Gears:

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

0.14 = ₹343m ÷ (₹3.3b - ₹858m) (Based on the trailing twelve months to June 2021).

Thus, Shanthi Gears has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 12% generated by the Machinery industry.

Check out our latest analysis for Shanthi Gears

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'd like to look at how Shanthi Gears has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Shanthi Gears' ROCE Trending?

Shanthi Gears has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 116% over the last five years. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 26% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

Our Take On Shanthi Gears' ROCE

As discussed above, Shanthi Gears appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 62% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

One more thing: We've identified 2 warning signs with Shanthi Gears (at least 1 which can't be ignored) , and understanding them would certainly be useful.

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.

If you decide to trade Shanthi Gears, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all 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.