Indian Oil (NSE:IOC) Might Be Having Difficulty Using Its Capital Effectively

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. In light of that, when we looked at Indian Oil (NSE:IOC) 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. Analysts use this formula to calculate it for Indian Oil:

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

0.14 = ₹296b ÷ (₹4.1t - ₹1.9t) (Based on the trailing twelve months to June 2022).

So, Indian Oil has an ROCE of 14%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Oil and Gas industry average of 13%.

Check out our latest analysis for Indian Oil

Above you can see how the current ROCE for Indian Oil 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 Indian Oil.

What Does the ROCE Trend For Indian Oil Tell Us?

On the surface, the trend of ROCE at Indian Oil doesn't inspire confidence. Over the last five years, returns on capital have decreased to 14% from 21% 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 side note, Indian Oil's current liabilities are still rather high at 47% of total assets. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Indian Oil. These growth trends haven't led to growth returns though, since the stock has fallen 24% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing: We've identified 3 warning signs with Indian Oil (at least 1 which makes us a bit uncomfortable) , and understanding them would certainly be useful.

While Indian Oil 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.