Damodar Industries' (NSE:DAMODARIND) Returns On Capital Not Reflecting Well On The Business

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Damodar Industries (NSE:DAMODARIND), it didn't seem to tick all of these boxes.

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 Damodar Industries:

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

0.16 = ₹470m ÷ (₹4.3b - ₹1.2b) (Based on the trailing twelve months to September 2021).

So, Damodar Industries has an ROCE of 16%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Luxury industry average of 13%.

View our latest analysis for Damodar Industries

Historical performance is a great place to start when researching a stock so above you can see the gauge for Damodar Industries' ROCE against it's prior returns. If you'd like to look at how Damodar Industries has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Damodar Industries' ROCE Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 22% five years ago, while the business's capital employed increased by 159%. That being said, Damodar Industries raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Damodar Industries' earnings and if they change as a result from the capital raise.

On a side note, Damodar Industries has done well to pay down its current liabilities to 29% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

While returns have fallen for Damodar Industries in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has done incredibly well with a 111% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you want to know some of the risks facing Damodar Industries we've found 5 warning signs (2 are concerning!) that you should be aware of before investing here.

While Damodar Industries 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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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.