Be Wary Of RITES (NSE:RITES) And Its Returns On Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after glancing at the trends within RITES (NSE:RITES), we weren't too hopeful.

What Is 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. To calculate this metric for RITES, this is the formula:

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

0.15 = ₹4.4b ÷ (₹59b - ₹30b) (Based on the trailing twelve months to December 2024).

So, RITES has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 11% generated by the Professional Services industry.

Check out our latest analysis for RITES

In the above chart we have measured RITES' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering RITES for free.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about RITES, given the returns are trending downwards. To be more specific, the ROCE was 23% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect RITES to turn into a multi-bagger.

On a side note, RITES' current liabilities are still rather high at 50% of total assets. 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 RITES' ROCE

In summary, it's unfortunate that RITES is generating lower returns from the same amount of capital. Yet despite these poor fundamentals, the stock has gained a huge 108% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you'd like to know about the risks facing RITES, we've discovered 1 warning sign that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.