Capital Allocation Trends At Bombay Dyeing and Manufacturing (NSE:BOMDYEING) Aren't Ideal

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after we looked into Bombay Dyeing and Manufacturing (NSE:BOMDYEING), the trends above didn't look too great.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Bombay Dyeing and Manufacturing:

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

0.01 = ₹241m ÷ (₹46b - ₹23b) (Based on the trailing twelve months to March 2021).

Therefore, Bombay Dyeing and Manufacturing has an ROCE of 1.0%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 9.5%.

See our latest analysis for Bombay Dyeing and Manufacturing

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 Bombay Dyeing and Manufacturing's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Bombay Dyeing and Manufacturing Tell Us?

There is reason to be cautious about Bombay Dyeing and Manufacturing, given the returns are trending downwards. To be more specific, the ROCE was 6.1% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Bombay Dyeing and Manufacturing to turn into a multi-bagger.

On a side note, Bombay Dyeing and Manufacturing's 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Bombay Dyeing and Manufacturing's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Yet despite these concerning fundamentals, the stock has performed strongly with a 43% return 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.

One more thing: We've identified 3 warning signs with Bombay Dyeing and Manufacturing (at least 2 which don't sit too well with us) , and understanding these would certainly be useful.

While Bombay Dyeing and Manufacturing may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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