The Returns On Capital At Ambika Cotton Mills (NSE:AMBIKCO) Don't Inspire Confidence

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Although, when we looked at Ambika Cotton Mills (NSE:AMBIKCO), 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. To calculate this metric for Ambika Cotton Mills, this is the formula:

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

0.12 = ₹1.0b ÷ (₹10b - ₹1.6b) (Based on the trailing twelve months to September 2023).

Therefore, Ambika Cotton Mills has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Luxury industry average of 10%.

See our latest analysis for Ambika Cotton Mills

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 Ambika Cotton Mills' past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Ambika Cotton Mills Tell Us?

When we looked at the ROCE trend at Ambika Cotton Mills, we didn't gain much confidence. To be more specific, ROCE has fallen from 19% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

The Bottom Line

We're a bit apprehensive about Ambika Cotton Mills because despite more capital being deployed in the business, returns on that capital and sales have both fallen. However the stock has delivered a 70% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Ambika Cotton Mills (including 1 which is potentially serious) .

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.