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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at ITC (NSE:ITC), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
Return On Capital Employed (ROCE): What is it?
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 ITC, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.24 = ₹150b ÷ (₹734b - ₹115b) (Based on the trailing twelve months to December 2020).
So, ITC has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Tobacco industry average of 19%.
In the above chart we have measured ITC's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For ITC Tell Us?
In terms of ITC's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 34%. However it looks like ITC might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
Bringing it all together, while we're somewhat encouraged by ITC's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 10% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
One final note, you should learn about the 2 warning signs we've spotted with ITC (including 1 which shouldn't be ignored) .
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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This article by Simply Wall St is general in nature. 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.
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