Investors Could Be Concerned With United Drilling Tools' (NSE:UNIDT) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 United Drilling Tools (NSE:UNIDT) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on United Drilling Tools is:

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

0.051 = ₹128m ÷ (₹2.8b - ₹286m) (Based on the trailing twelve months to June 2023).

Therefore, United Drilling Tools has an ROCE of 5.1%. In absolute terms, that's a low return, but it's much better than the Energy Services industry average of 1.1%.

Check out our latest analysis for United Drilling Tools

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating United Drilling Tools' past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at United Drilling Tools, we didn't gain much confidence. To be more specific, ROCE has fallen from 17% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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, United Drilling Tools has done well to pay down its current liabilities to 10% of total assets. That could partly explain why the ROCE has dropped. 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 Bottom Line

We're a bit apprehensive about United Drilling Tools because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors haven't taken kindly to these developments, since the stock has declined 17% from where it was three years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

United Drilling Tools does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.