Some Investors May Be Worried About Shri Ram Switchgears' (NSE:SRIRAM) Returns On Capital

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Shri Ram Switchgears (NSE:SRIRAM) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Shri Ram Switchgears is:

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

0.064 = ₹29m ÷ (₹839m - ₹386m) (Based on the trailing twelve months to March 2020).

Thus, Shri Ram Switchgears has an ROCE of 6.4%. Ultimately, that's a low return and it under-performs the Electrical industry average of 11%.

View our latest analysis for Shri Ram Switchgears

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shri Ram Switchgears' ROCE against it's prior returns. If you'd like to look at how Shri Ram Switchgears has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of Shri Ram Switchgears' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 6.4% from 17% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

Another thing to note, Shri Ram Switchgears has a high ratio of current liabilities to total assets of 46%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Shri Ram Switchgears' ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Shri Ram Switchgears have fallen, meanwhile the business is employing more capital than it was five years ago. And, the stock has remained flat over the last three years, so investors don't seem too impressed either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One final note, you should learn about the 5 warning signs we've spotted with Shri Ram Switchgears (including 4 which are potentially serious) .

While Shri Ram Switchgears isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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