There Are Reasons To Feel Uneasy About Indian Oil's (NSE:IOC) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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 Indian Oil (NSE:IOC) and its ROCE trend, we weren't exactly thrilled.

What Is 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. The formula for this calculation on Indian Oil is:

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

0.11 = ₹238b ÷ (₹4.5t - ₹2.3t) (Based on the trailing twelve months to December 2022).

Thus, Indian Oil has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Oil and Gas industry average of 12%.

See our latest analysis for Indian Oil

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.

The Trend Of ROCE

When we looked at the ROCE trend at Indian Oil, we didn't gain much confidence. Around five years ago the returns on capital were 22%, but since then they've fallen to 11%. 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.

On a side note, Indian Oil's current liabilities are still rather high at 51% 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.

The Bottom Line On Indian Oil's ROCE

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. However, total returns to shareholders over the last five years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you'd like to know more about Indian Oil, we've spotted 3 warning signs, and 1 of them doesn't sit too well with us.

While Indian Oil may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.