Returns On Capital At Indian Oil (NSE:IOC) Paint A Concerning Picture

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Indian Oil (NSE:IOC) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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)

0.10 = ₹225b ÷ (₹4.5t - ₹2.3t) (Based on the trailing twelve months to September 2022).

Thus, Indian Oil has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Oil and Gas industry average of 12%.

Our analysis indicates that IOC is potentially undervalued!

In the above chart we have measured Indian Oil's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Indian Oil.

What The Trend Of ROCE Can Tell Us

In terms of Indian Oil's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 21%, but since then they've fallen to 10%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Another thing to note, Indian Oil has a high ratio of current liabilities to total assets of 51%. 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.

Our Take On Indian Oil's ROCE

While returns have fallen for Indian Oil in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And there could be an opportunity here if other metrics look good too, because the stock has declined 16% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you want to know some of the risks facing Indian Oil we've found 3 warning signs (1 shouldn't be ignored!) that you should be aware of before investing here.

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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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.