To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. So on that note, Lloyds Steels Industries (NSE:LSIL) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Lloyds Steels Industries, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.012 = ₹15m ÷ (₹1.5b - ₹299m) (Based on the trailing twelve months to March 2021).
Thus, Lloyds Steels Industries has an ROCE of 1.2%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 12%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Lloyds Steels Industries' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Lloyds Steels Industries, check out these free graphs here.
So How Is Lloyds Steels Industries' ROCE Trending?
The fact that Lloyds Steels Industries is now generating some pre-tax profits from its prior investments is very encouraging. About five years ago the company was generating losses but things have turned around because it's now earning 1.2% on its capital. Not only that, but the company is utilizing 26% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
On a related note, the company's ratio of current liabilities to total assets has decreased to 20%, which basically reduces it's funding from the likes of short-term creditors or suppliers. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
The Bottom Line
Long story short, we're delighted to see that Lloyds Steels Industries' reinvestment activities have paid off and the company is now profitable. And with a respectable 75% awarded to those who held the stock over the last three years, you could argue that these developments are starting to get the attention they deserve. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing to note, we've identified 3 warning signs with Lloyds Steels Industries and understanding these should be part of your investment process.
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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