Should You Be Impressed By Chembond Chemicals' (NSE:CHEMBOND) Returns on Capital?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after briefly looking over the numbers, we don't think Chembond Chemicals (NSE:CHEMBOND) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Chembond Chemicals:

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

0.024 = ₹68m ÷ (₹3.3b - ₹442m) (Based on the trailing twelve months to September 2020).

Therefore, Chembond Chemicals has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 14%.

See our latest analysis for Chembond Chemicals

Historical performance is a great place to start when researching a stock so above you can see the gauge for Chembond Chemicals' ROCE against it's prior returns. If you're interested in investigating Chembond Chemicals' past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Chembond Chemicals' ROCE Trend?

When we looked at the ROCE trend at Chembond Chemicals, we didn't gain much confidence. Around five years ago the returns on capital were 8.8%, but since then they've fallen to 2.4%. 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.

On a side note, Chembond Chemicals has done well to pay down its current liabilities to 13% 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 Chembond Chemicals' ROCE

We're a bit apprehensive about Chembond Chemicals because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Long term shareholders who've owned the stock over the last year have experienced a 22% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing: We've identified 4 warning signs with Chembond Chemicals (at least 1 which is a bit unpleasant) , and understanding them would certainly be useful.

While Chembond Chemicals may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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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