There Are Reasons To Feel Uneasy About S.P. Apparels' (NSE:SPAL) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at S.P. Apparels (NSE:SPAL) and its ROCE trend, we weren't exactly thrilled.

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

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. The formula for this calculation on S.P. Apparels is:

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

0.10 = ₹653m ÷ (₹9.4b - ₹3.1b) (Based on the trailing twelve months to December 2020).

Therefore, S.P. Apparels has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Luxury industry average of 9.5%.

View our latest analysis for S.P. Apparels

Above you can see how the current ROCE for S.P. Apparels 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 S.P. Apparels here for free.

What Can We Tell From S.P. Apparels' ROCE Trend?

On the surface, the trend of ROCE at S.P. Apparels doesn't inspire confidence. To be more specific, ROCE has fallen from 28% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, S.P. Apparels has done well to pay down its current liabilities to 33% 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

We're a bit apprehensive about S.P. Apparels because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Long term shareholders who've owned the stock over the last three years have experienced a 59% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you'd like to know about the risks facing S.P. Apparels, we've discovered 2 warning signs that you should be aware of.

While S.P. Apparels 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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