20 Microns (NSE:20MICRONS) Will Be Hoping To Turn Its Returns On Capital Around

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at 20 Microns (NSE:20MICRONS), it didn't seem to tick all of these boxes.

What is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for 20 Microns:

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

0.14 = ₹357m ÷ (₹4.2b - ₹1.7b) (Based on the trailing twelve months to December 2020).

Thus, 20 Microns has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 16% generated by the Chemicals industry.

View our latest analysis for 20 Microns

Historical performance is a great place to start when researching a stock so above you can see the gauge for 20 Microns' ROCE against it's prior returns. If you'd like to look at how 20 Microns has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For 20 Microns Tell Us?

When we looked at the ROCE trend at 20 Microns, we didn't gain much confidence. Around five years ago the returns on capital were 19%, but since then they've fallen to 14%. 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, 20 Microns has a high ratio of current liabilities to total assets of 40%. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

We're a bit apprehensive about 20 Microns because despite more capital being deployed in the business, returns on that capital and sales have both fallen. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 95% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you'd like to know more about 20 Microns, we've spotted 4 warning signs, and 1 of them is concerning.

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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