What Can The Trends At Spectrum Electrical Industries (NSE:SPECTRUM) Tell Us About Their Returns?

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Spectrum Electrical Industries (NSE:SPECTRUM) and its trend of ROCE, we really liked what we saw.

Understanding 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 Spectrum Electrical Industries is:

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

0.12 = ₹131m ÷ (₹1.5b - ₹475m) (Based on the trailing twelve months to September 2019).

Therefore, Spectrum Electrical Industries has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 11% generated by the Electrical industry.

Check out our latest analysis for Spectrum Electrical Industries

Historical performance is a great place to start when researching a stock so above you can see the gauge for Spectrum Electrical Industries' ROCE against it's prior returns. 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

The fact that Spectrum Electrical Industries is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 12% on its capital. And unsurprisingly, like most companies trying to break into the black, Spectrum Electrical Industries is utilizing 3,577% more capital than it was five years ago. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

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 31% 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.

The Bottom Line

Overall, Spectrum Electrical Industries gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Investors may not be impressed by the favorable underlying trends yet because over the last year the stock has only returned 5.5% to shareholders. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

One final note, you should learn about the 3 warning signs we've spotted with Spectrum Electrical Industries (including 1 which can't be ignored) .

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.

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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.
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