Gujarat Narmada Valley Fertilizers & Chemicals (NSE:GNFC) Knows How To Allocate Capital Effectively

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. So when we looked at the ROCE trend of Gujarat Narmada Valley Fertilizers & Chemicals (NSE:GNFC) we really liked what we saw.

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 Gujarat Narmada Valley Fertilizers & Chemicals is:

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

0.22 = ₹21b ÷ (₹107b - ₹14b) (Based on the trailing twelve months to March 2022).

So, Gujarat Narmada Valley Fertilizers & Chemicals has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Chemicals industry average of 17%.

View our latest analysis for Gujarat Narmada Valley Fertilizers & Chemicals

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'd like to look at how Gujarat Narmada Valley Fertilizers & Chemicals has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

Investors would be pleased with what's happening at Gujarat Narmada Valley Fertilizers & Chemicals. Over the last five years, returns on capital employed have risen substantially to 22%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 60%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 13%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So this improvement in ROCE has come from the business' underlying economics, which is great to see.

Our Take On Gujarat Narmada Valley Fertilizers & Chemicals' ROCE

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Gujarat Narmada Valley Fertilizers & Chemicals has. Since the stock has returned a staggering 154% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

One more thing to note, we've identified 2 warning signs with Gujarat Narmada Valley Fertilizers & Chemicals and understanding them should be part of your investment process.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.