Be Wary Of Dr. Lal PathLabs (NSE:LALPATHLAB) And Its Returns On Capital

What trends should we look for it we want to identify stocks that can 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, while the ROCE is currently high for Dr. Lal PathLabs (NSE:LALPATHLAB), we aren't jumping out of our chairs because returns are decreasing.

Understanding 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. To calculate this metric for Dr. Lal PathLabs, this is the formula:

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

0.25 = ₹4.5b ÷ (₹24b - ₹5.0b) (Based on the trailing twelve months to March 2022).

Thus, Dr. Lal PathLabs has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.

Check out our latest analysis for Dr. Lal PathLabs

In the above chart we have measured Dr. Lal PathLabs' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Dr. Lal PathLabs here for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Dr. Lal PathLabs doesn't inspire confidence. While it's comforting that the ROCE is high, five years ago it was 35%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line On Dr. Lal PathLabs' 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 Dr. Lal PathLabs. And long term investors must be optimistic going forward because the stock has returned a huge 155% to shareholders in the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Dr. Lal PathLabs does have some risks, we noticed 4 warning signs (and 1 which is concerning) we think you should know about.

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. 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.