Here's What To Make Of 20 Microns' (NSE:20MICRONS) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. That's why when we briefly looked at 20 Microns' (NSE:20MICRONS) ROCE trend, we were pretty happy with what we saw.

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. To calculate this metric for 20 Microns, this is the formula:

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

0.14 = ₹344m ÷ (₹4.2b - ₹1.7b) (Based on the trailing twelve months to September 2020).

So, 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.

Check out 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.

How Are Returns Trending?

The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has consistently earned 14% for the last five years, and the capital employed within the business has risen 47% in that time. 14% is a pretty standard return, and it provides some comfort knowing that 20 Microns has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.

On a side note, 20 Microns' current liabilities are still rather high at 40% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

To sum it up, 20 Microns has simply been reinvesting capital steadily, at those decent rates of return. Therefore it's no surprise that shareholders have earned a respectable 48% return if they held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.

One more thing: We've identified 5 warning signs with 20 Microns (at least 1 which is concerning) , and understanding these would certainly be useful.

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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