Capital Allocation Trends At Megastar Foods (NSE:MEGASTAR) Aren't Ideal

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after investigating Megastar Foods (NSE:MEGASTAR), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on Megastar Foods is:

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

0.08 = ₹106m ÷ (₹1.6b - ₹220m) (Based on the trailing twelve months to March 2024).

Thus, Megastar Foods has an ROCE of 8.0%. Ultimately, that's a low return and it under-performs the Food industry average of 13%.

View our latest analysis for Megastar Foods

Historical performance is a great place to start when researching a stock so above you can see the gauge for Megastar Foods' ROCE against it's prior returns. If you'd like to look at how Megastar Foods has performed in the past in other metrics, you can view this free graph of Megastar Foods' past earnings, revenue and cash flow.

The Trend Of ROCE

Unfortunately, the trend isn't great with ROCE falling from 24% five years ago, while capital employed has grown 392%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Megastar Foods might not have received a full period of earnings contribution from it.

On a related note, Megastar Foods has decreased its current liabilities to 14% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Megastar Foods' ROCE

Bringing it all together, while we're somewhat encouraged by Megastar Foods' reinvestment in its own business, we're aware that returns are shrinking. And in the last year, the stock has given away 20% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Megastar Foods has the makings of a multi-bagger.

If you want to know some of the risks facing Megastar Foods we've found 5 warning signs (2 are a bit concerning!) that you should be aware of before investing here.

While Megastar Foods 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.