Punjab Chemicals and Crop Protection (NSE:PUNJABCHEM) Is Reinvesting At Lower Rates Of Return

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, while the ROCE is currently high for Punjab Chemicals and Crop Protection (NSE:PUNJABCHEM), we aren't jumping out of our chairs because returns are decreasing.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Punjab Chemicals and Crop Protection is:

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

0.20 = ₹803m ÷ (₹6.4b - ₹2.4b) (Based on the trailing twelve months to June 2024).

So, Punjab Chemicals and Crop Protection has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.

See our latest analysis for Punjab Chemicals and Crop Protection

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Punjab Chemicals and Crop Protection.

So How Is Punjab Chemicals and Crop Protection's ROCE Trending?

On the surface, the trend of ROCE at Punjab Chemicals and Crop Protection doesn't inspire confidence. While it's comforting that the ROCE is high, five years ago it was 44%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Punjab Chemicals and Crop Protection has done well to pay down its current liabilities to 37% of total assets. So we could link some of this to the decrease 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.

In Conclusion...

In summary, we're somewhat concerned by Punjab Chemicals and Crop Protection's diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 116% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Like most companies, Punjab Chemicals and Crop Protection does come with some risks, and we've found 1 warning sign 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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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.