Here's What To Make Of RITES' (NSE:RITES) Decelerating Rates Of Return

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at RITES (NSE:RITES), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

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. Analysts use this formula to calculate it for RITES:

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

0.21 = ₹6.0b ÷ (₹58b - ₹28b) (Based on the trailing twelve months to December 2023).

Thus, RITES has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Professional Services industry average of 13%.

See 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.

The Trend Of ROCE

Over the past five years, RITES' ROCE and capital employed have both remained mostly flat. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So while the current operations are delivering respectable returns, unless capital employed increases we'd be hard-pressed to believe it's a multi-bagger going forward. That probably explains why RITES has been paying out 69% of its earnings as dividends to shareholders. If the company is in fact lacking growth opportunities, that's one of the viable alternatives for the money.

Another thing to note, RITES has a high ratio of current liabilities to total assets of 49%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On RITES' ROCE

In summary, RITES isn't compounding its earnings but is generating decent returns on the same amount of capital employed. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 359% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

If you'd like to know about the risks facing RITES, we've discovered 2 warning signs that you should be aware of.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.