If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Godfrey Phillips India (NSE:GODFRYPHLP) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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. To calculate this metric for Godfrey Phillips India, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = ₹3.2b ÷ (₹35b - ₹8.1b) (Based on the trailing twelve months to December 2020).
Therefore, Godfrey Phillips India has an ROCE of 12%. In isolation, that's a pretty standard return but against the Tobacco industry average of 21%, it's not as good.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Godfrey Phillips India's ROCE against it's prior returns. If you'd like to look at how Godfrey Phillips India has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From Godfrey Phillips India's ROCE Trend?
When we looked at the ROCE trend at Godfrey Phillips India, we didn't gain much confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 12%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Bottom Line On Godfrey Phillips India's ROCE
We're a bit apprehensive about Godfrey Phillips India 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 18% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One more thing, we've spotted 2 warning signs facing Godfrey Phillips India that you might find interesting.
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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