Aarvi Encon's (NSE:AARVI) 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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Aarvi Encon (NSE:AARVI), it didn't seem to tick all of these boxes.

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. Analysts use this formula to calculate it for Aarvi Encon:

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

0.12 = ₹117m ÷ (₹1.5b - ₹524m) (Based on the trailing twelve months to March 2022).

Thus, Aarvi Encon has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 11% generated by the Professional Services industry.

View our latest analysis for Aarvi Encon

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

So How Is Aarvi Encon's ROCE Trending?

On the surface, the trend of ROCE at Aarvi Encon doesn't inspire confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 12%. 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.

On a side note, Aarvi Encon has done well to pay down its current liabilities to 35% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Aarvi Encon's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Aarvi Encon. And the stock has done incredibly well with a 175% return over the last three years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One more thing: We've identified 4 warning signs with Aarvi Encon (at least 1 which makes us a bit uncomfortable) , and understanding these would certainly be useful.

While Aarvi Encon 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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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.