Some Investors May Be Worried About HP Adhesives' (NSE:HPAL) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating HP Adhesives (NSE:HPAL), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

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 HP Adhesives, this is the formula:

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

0.14 = ₹228m ÷ (₹1.9b - ₹287m) (Based on the trailing twelve months to September 2023).

So, HP Adhesives has an ROCE of 14%. By itself that's a normal return on capital and it's in line with the industry's average returns of 14%.

Check out our latest analysis for HP Adhesives

Historical performance is a great place to start when researching a stock so above you can see the gauge for HP Adhesives' ROCE against it's prior returns. If you'd like to look at how HP Adhesives has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From HP Adhesives' ROCE Trend?

On the surface, the trend of ROCE at HP Adhesives doesn't inspire confidence. Around three years ago the returns on capital were 52%, but since then they've fallen to 14%. However it looks like HP Adhesives might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, HP Adhesives has done well to pay down its current liabilities to 15% of total assets. Considering it used to be 81%, that's a huge drop in that ratio and it would explain the decline in ROCE. 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 HP Adhesives' ROCE

To conclude, we've found that HP Adhesives is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 53% over the last year. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

While HP Adhesives doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

While HP Adhesives 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. 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.