United Spirits' (NSE:MCDOWELL-N) Returns On Capital Not Reflecting Well On The Business

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, while the ROCE is currently high for United Spirits (NSE:MCDOWELL-N), we aren't jumping out of our chairs because returns are decreasing.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for United Spirits:

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

0.25 = ₹10b ÷ (₹85b - ₹43b) (Based on the trailing twelve months to June 2021).

Therefore, United Spirits has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Beverage industry average of 11%.

View our latest analysis for United Spirits

Above you can see how the current ROCE for United Spirits compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for United Spirits.

What Can We Tell From United Spirits' ROCE Trend?

When we looked at the ROCE trend at United Spirits, we didn't gain much confidence. Historically returns on capital were even higher at 33%, but they have dropped over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, United Spirits has done well to pay down its current liabilities to 51% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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. Keep in mind 51% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line On United Spirits' 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 United Spirits. Furthermore the stock has climbed 49% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you're still interested in United Spirits it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

If you’re looking to trade United Spirits, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.