Rupa (NSE:RUPA) Could Be Struggling To Allocate Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Looking at Rupa (NSE:RUPA), it does have a high ROCE right now, but lets see how returns are trending.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Rupa:

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

0.25 = ₹1.6b ÷ (₹9.9b - ₹3.5b) (Based on the trailing twelve months to December 2020).

Thus, Rupa has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 9.5% earned by companies in a similar industry.

View our latest analysis for Rupa

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

How Are Returns Trending?

In terms of Rupa's historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 31%, but they have dropped over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. 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.

On a related note, Rupa has decreased its current liabilities to 35% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for Rupa have fallen, meanwhile the business is employing more capital than it was five years ago. Investors must expect better things on the horizon though because the stock has risen 18% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing to note, we've identified 2 warning signs with Rupa and understanding them should be part of your investment process.

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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