Should We Be Excited About The Trends Of Returns At GHCL (NSE:GHCL)?

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Having said that, from a first glance at GHCL (NSE:GHCL) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. The formula for this calculation on GHCL is:

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

0.14 = ₹4.5b ÷ (₹40b - ₹8.0b) (Based on the trailing twelve months to December 2020).

Therefore, GHCL has an ROCE of 14%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Chemicals industry average of 15%.

View our latest analysis for GHCL

Above you can see how the current ROCE for GHCL compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for GHCL.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at GHCL doesn't inspire confidence. Over the last five years, returns on capital have decreased to 14% from 29% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, GHCL has done well to pay down its current liabilities to 20% 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.

What We Can Learn From GHCL's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for GHCL have fallen, meanwhile the business is employing more capital than it was five years ago. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 136%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a separate note, we've found 2 warning signs for GHCL you'll probably want to know about.

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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