If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Speaking of which, we noticed some great changes in Emami Paper Mills' (NSE:EMAMIPAP) returns on capital, so let's have a look.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Emami Paper Mills, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = ₹2.2b ÷ (₹19b - ₹8.4b) (Based on the trailing twelve months to December 2021).
So, Emami Paper Mills has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Forestry industry average of 12%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Emami Paper Mills' past further, check out this free graph of past earnings, revenue and cash flow.
What Can We Tell From Emami Paper Mills' ROCE Trend?
Emami Paper Mills has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 210% over the last five years. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 45% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.
The Bottom Line On Emami Paper Mills' ROCE
To bring it all together, Emami Paper Mills has done well to increase the returns it's generating from its capital employed. Since the stock has returned a solid 44% to shareholders over the last year, it's fair to say investors are beginning to recognize these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Emami Paper Mills does have some risks, we noticed 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.
High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.