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

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Looking at Dr. Lal PathLabs (NSE:LALPATHLAB), it does have a high ROCE right now, but lets see how returns are trending.

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. Analysts use this formula to calculate it for Dr. Lal PathLabs:

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

0.22 = ₹4.4b ÷ (₹24b - ₹4.7b) (Based on the trailing twelve months to December 2023).

Therefore, Dr. Lal PathLabs has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 14% 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're interested, you can view the analysts predictions in our free analyst report for Dr. Lal PathLabs .

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Dr. Lal PathLabs, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 29% where it was five years ago. However it looks like Dr. Lal PathLabs might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Dr. Lal PathLabs' reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 130% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing to note, we've identified 2 warning signs with Dr. Lal PathLabs and understanding them should be part of your investment process.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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.