Parag Milk Foods (NSE:PARAGMILK) Is Reinvesting At Lower Rates Of Return

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Parag Milk Foods (NSE:PARAGMILK) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What is it?

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. To calculate this metric for Parag Milk Foods, this is the formula:

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

0.075 = ₹1.0b ÷ (₹19b - ₹5.0b) (Based on the trailing twelve months to September 2021).

Thus, Parag Milk Foods has an ROCE of 7.5%. Ultimately, that's a low return and it under-performs the Food industry average of 12%.

Check out our latest analysis for Parag Milk Foods

In the above chart we have measured Parag Milk Foods' 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 Can We Tell From Parag Milk Foods' ROCE Trend?

Unfortunately, the trend isn't great with ROCE falling from 15% five years ago, while capital employed has grown 75%. That being said, Parag Milk Foods raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Parag Milk Foods might not have received a full period of earnings contribution from it.

On a side note, Parag Milk Foods has done well to pay down its current liabilities to 26% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Parag Milk Foods' ROCE

In summary, we're somewhat concerned by Parag Milk Foods' diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 58% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we've found 3 warning signs for Parag Milk Foods that we think you should be aware of.

While Parag Milk Foods isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.