Here's What To Make Of Asian Paints' (NSE:ASIANPAINT) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Looking at Asian Paints (NSE:ASIANPAINT), it does have a high ROCE right now, but lets see how returns are trending.

What is Return On Capital Employed (ROCE)?

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 Asian Paints, this is the formula:

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

0.29 = ₹36b ÷ (₹174b - ₹47b) (Based on the trailing twelve months to December 2020).

Therefore, Asian Paints has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Chemicals industry average of 15%.

Check out our latest analysis for Asian Paints

In the above chart we have measured Asian Paints' 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 Asian Paints here for free.

The Trend Of ROCE

When we looked at the ROCE trend at Asian Paints, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 40% where it was five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Asian Paints has decreased its current liabilities to 27% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

Our Take On Asian Paints' ROCE

Bringing it all together, while we're somewhat encouraged by Asian Paints' reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 189% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

While Asian Paints doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

Asian Paints is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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This article by Simply Wall St is general in nature. 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.
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