Aarvi Encon's (NSE:AARVI) Returns On Capital Not Reflecting Well On The Business

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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Aarvi Encon (NSE:AARVI), we don't think it's current trends fit the mold of a multi-bagger.

What Is 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 Aarvi Encon is:

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

0.14 = ₹140m ÷ (₹1.6b - ₹572m) (Based on the trailing twelve months to June 2022).

Therefore, Aarvi Encon has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 12% generated by the Professional Services industry.

Our analysis indicates that AARVI is potentially undervalued!

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're interested in investigating Aarvi Encon's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Aarvi Encon's ROCE Trend?

When we looked at the ROCE trend at Aarvi Encon, we didn't gain much confidence. To be more specific, ROCE has fallen from 20% over the last five years. 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.

Our Take 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 long term investors must be optimistic going forward because the stock has returned a huge 149% to shareholders in the last five years. 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.

Aarvi Encon does have some risks, we noticed 3 warning signs (and 1 which is potentially serious) we think you should know about.

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.

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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.