Suryalakshmi Cotton Mills (NSE:SURYALAXMI) May Have Issues Allocating Its Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. And from a first read, things don't look too good at Suryalakshmi Cotton Mills (NSE:SURYALAXMI), so let's see why.

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

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Suryalakshmi Cotton Mills, this is the formula:

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

0.046 = ₹167m ÷ (₹6.9b - ₹3.3b) (Based on the trailing twelve months to March 2021).

Thus, Suryalakshmi Cotton Mills has an ROCE of 4.6%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 9.6%.

View our latest analysis for Suryalakshmi Cotton Mills

Historical performance is a great place to start when researching a stock so above you can see the gauge for Suryalakshmi Cotton Mills' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Suryalakshmi Cotton Mills, check out these free graphs here.

What Can We Tell From Suryalakshmi Cotton Mills' ROCE Trend?

The trend of returns that Suryalakshmi Cotton Mills is generating are raising some concerns. Unfortunately, returns have declined substantially over the last five years to the 4.6% we see today. In addition to that, Suryalakshmi Cotton Mills is now employing 34% less capital than it was five years ago. The fact that both are shrinking is an indication that the business is going through some tough times. If these underlying trends continue, we wouldn't be too optimistic going forward.

Another thing to note, Suryalakshmi Cotton Mills has a high ratio of current liabilities to total assets of 47%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

To see Suryalakshmi Cotton Mills reducing the capital employed in the business in tandem with diminishing returns, is concerning. This could explain why the stock has sunk a total of 72% in the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One final note, you should learn about the 4 warning signs we've spotted with Suryalakshmi Cotton Mills (including 3 which are concerning) .

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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