Sheela Foam (NSE:SFL) Will Be Hoping To Turn Its Returns On Capital Around

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Sheela Foam (NSE:SFL) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Sheela Foam:

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

0.16 = ₹2.8b ÷ (₹24b - ₹5.6b) (Based on the trailing twelve months to June 2022).

Thus, Sheela Foam has an ROCE of 16%. That's a relatively normal return on capital, and it's around the 15% generated by the Consumer Durables industry.

See 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 to see what analysts are forecasting going forward, you should check out our free report for Sheela Foam.

The Trend Of ROCE

In terms of Sheela Foam's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 16% from 30% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. 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 24% 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. 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

In summary, despite lower returns in the short term, we're encouraged to see that Sheela Foam is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 135% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

While Sheela Foam doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

While Sheela Foam isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.