Some Investors May Be Worried About Airo Lam's (NSE:AIROLAM) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Airo Lam (NSE:AIROLAM), it didn't seem to tick all of these boxes.

Understanding 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. The formula for this calculation on Airo Lam is:

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

0.15 = ₹119m ÷ (₹1.5b - ₹720m) (Based on the trailing twelve months to September 2021).

Therefore, Airo Lam has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 9.8% generated by the Forestry industry.

See our latest analysis for Airo Lam

Historical performance is a great place to start when researching a stock so above you can see the gauge for Airo Lam's ROCE against it's prior returns. If you'd like to look at how Airo Lam 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 Airo Lam Tell Us?

In terms of Airo Lam's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 20% over the last five years. 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, Airo Lam has decreased its current liabilities to 48% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that Airo Lam is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 130% return over the last three years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

One more thing, we've spotted 3 warning signs facing Airo Lam that you might find interesting.

While Airo Lam 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.