Neogen Chemicals (NSE:NEOGEN) May Have Issues Allocating Its Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. 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, while the ROCE is currently high for Neogen Chemicals (NSE:NEOGEN), we aren't jumping out of our chairs because returns are decreasing.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Neogen Chemicals:

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

0.24 = ₹549m ÷ (₹3.9b - ₹1.6b) (Based on the trailing twelve months to December 2020).

Thus, Neogen Chemicals has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Chemicals industry average of 15%.

See our latest analysis for Neogen Chemicals

In the above chart we have measured Neogen Chemicals' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Neogen Chemicals.

So How Is Neogen Chemicals' ROCE Trending?

In terms of Neogen Chemicals' historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 39%, but they have dropped over the last five years. However it looks like Neogen Chemicals 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, Neogen Chemicals has done well to pay down its current liabilities to 40% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

What We Can Learn From Neogen Chemicals' ROCE

Bringing it all together, while we're somewhat encouraged by Neogen Chemicals' reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 145% return in the last year, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Neogen Chemicals does have some risks though, and we've spotted 1 warning sign for Neogen Chemicals that you might be interested in.

Neogen Chemicals is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

If you’re looking to trade Neogen Chemicals, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.