Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Looking at Orient Refractories (NSE:ORIENTREF), it does have a high ROCE right now, but lets see how returns are trending.
Understanding Return On Capital Employed (ROCE)
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. The formula for this calculation on Orient Refractories is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.22 = ₹934m ÷ (₹5.8b - ₹1.5b) (Based on the trailing twelve months to December 2020).
Thus, Orient Refractories has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Basic Materials industry average of 13%.
Above you can see how the current ROCE for Orient Refractories compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
On the surface, the trend of ROCE at Orient Refractories doesn't inspire confidence. While it's comforting that the ROCE is high, five years ago it was 37%. However it looks like Orient Refractories 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 may take some time before the company starts to see any change in earnings from these investments.
Our Take On Orient Refractories' ROCE
To conclude, we've found that Orient Refractories is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 281% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Like most companies, Orient Refractories does come with some risks, and we've found 2 warning signs that you should be aware of.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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