If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Looking at Sheela Foam (NSE:SFL), it does have a high ROCE right now, but lets see how returns are trending.
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. To calculate this metric for Sheela Foam, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.22 = ₹3.4b ÷ (₹21b - ₹5.4b) (Based on the trailing twelve months to March 2021).
Thus, Sheela Foam has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Consumer Durables industry average of 11%.
Check out our latest analysis for Sheela Foam
Above you can see how the current ROCE for Sheela Foam compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Sheela Foam here for free.
What Does the ROCE Trend For Sheela Foam Tell Us?
When we looked at the ROCE trend at Sheela Foam, we didn't gain much confidence. Historically returns on capital were even higher at 36%, but they have dropped over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
On a related note, Sheela Foam has decreased its current liabilities to 26% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
In Conclusion...
While returns have fallen for Sheela Foam in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 43% over the last three years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
Sheela Foam could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
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. 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.
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About NSEI:SFL
Sheela Foam
Engages in the manufacture and sale of polyurethane foams and mattresses in India and internationally.
Reasonable growth potential with adequate balance sheet.
