Be Wary Of Jyothy Labs (NSE:JYOTHYLAB) 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? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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, from a first glance at Jyothy Labs (NSE:JYOTHYLAB) 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 who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Jyothy Labs:

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

0.17 = ₹2.4b ÷ (₹19b - ₹4.7b) (Based on the trailing twelve months to September 2021).

Thus, Jyothy Labs has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 14% generated by the Household Products industry.

View our latest analysis for Jyothy Labs

In the above chart we have measured Jyothy Labs' 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 Jyothy Labs here for free.

How Are Returns Trending?

In terms of Jyothy Labs' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 17% from 22% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Jyothy Labs has decreased its current liabilities to 25% of total assets. So we could link some of this to the decrease in ROCE. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Jyothy Labs' 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 Jyothy Labs. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Jyothy Labs does have some risks though, and we've spotted 2 warning signs for Jyothy Labs that you might be interested in.

While Jyothy Labs 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.