Gujarat State Fertilizers & Chemicals (NSE:GSFC) Might Be Having Difficulty Using Its Capital Effectively

There are a few key trends to look for if we want to identify the next multi-bagger. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Gujarat State Fertilizers & Chemicals (NSE:GSFC), it didn't seem to tick all of these boxes.

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. To calculate this metric for Gujarat State Fertilizers & Chemicals, this is the formula:

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

0.028 = ₹4.1b ÷ (₹159b - ₹14b) (Based on the trailing twelve months to September 2024).

Therefore, Gujarat State Fertilizers & Chemicals has an ROCE of 2.8%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 13%.

View our latest analysis for Gujarat State Fertilizers & Chemicals

In the above chart we have measured Gujarat State Fertilizers & Chemicals' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Gujarat State Fertilizers & Chemicals .

What Does the ROCE Trend For Gujarat State Fertilizers & Chemicals Tell Us?

In terms of Gujarat State Fertilizers & Chemicals' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 2.8% from 6.1% five years ago. 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, Gujarat State Fertilizers & Chemicals has done well to pay down its current liabilities to 8.5% 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. 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.

The Bottom Line

In summary, we're somewhat concerned by Gujarat State Fertilizers & Chemicals' diminishing returns on increasing amounts of capital. Since the stock has skyrocketed 235% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing, we've spotted 2 warning signs facing Gujarat State Fertilizers & Chemicals that you might find interesting.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.