Sarveshwar Foods' (NSE:SARVESHWAR) Returns On Capital Not Reflecting Well On The Business

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after investigating Sarveshwar Foods (NSE:SARVESHWAR), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Sarveshwar Foods is:

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

0.087 = ₹141m ÷ (₹5.1b - ₹3.5b) (Based on the trailing twelve months to September 2020).

So, Sarveshwar Foods has an ROCE of 8.7%. Ultimately, that's a low return and it under-performs the Food industry average of 12%.

Check out our latest analysis for Sarveshwar Foods

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Sarveshwar Foods has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Sarveshwar Foods' ROCE Trending?

When we looked at the ROCE trend at Sarveshwar Foods, we didn't gain much confidence. Around five years ago the returns on capital were 39%, but since then they've fallen to 8.7%. 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.

Another thing to note, Sarveshwar Foods has a high ratio of current liabilities to total assets of 68%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Sarveshwar Foods' ROCE

In summary, we're somewhat concerned by Sarveshwar Foods' diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 49% from where it was three years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Sarveshwar Foods does come with some risks though, we found 5 warning signs in our investment analysis, and 3 of those can't be ignored...

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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