Spectrum Electrical Industries' (NSE:SPECTRUM) Returns On Capital Not Reflecting Well On The Business

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Spectrum Electrical Industries (NSE:SPECTRUM) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Spectrum Electrical Industries is:

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

0.11 = ₹145m ÷ (₹2.3b - ₹1.0b) (Based on the trailing twelve months to September 2022).

Thus, Spectrum Electrical Industries has an ROCE of 11%. In absolute terms, that's a pretty standard return but compared to the Electrical industry average it falls behind.

View our latest analysis for Spectrum Electrical Industries

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 Spectrum Electrical Industries has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

On the surface, the trend of ROCE at Spectrum Electrical Industries doesn't inspire confidence. Over the last five years, returns on capital have decreased to 11% from 18% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

Another thing to note, Spectrum Electrical Industries has a high ratio of current liabilities to total assets of 43%. 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 On Spectrum Electrical Industries' ROCE

While returns have fallen for Spectrum Electrical Industries in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 81% to shareholders over the last year. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Spectrum Electrical Industries does have some risks, we noticed 5 warning signs (and 2 which shouldn't be ignored) we think you should know about.

While Spectrum Electrical Industries 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.

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

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.