Rama Steel Tubes (NSE:RAMASTEEL) 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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. However, after briefly looking over the numbers, we don't think Rama Steel Tubes (NSE:RAMASTEEL) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

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. The formula for this calculation on Rama Steel Tubes is:

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

0.10 = ₹118m ÷ (₹2.2b - ₹1.0b) (Based on the trailing twelve months to December 2020).

So, Rama Steel Tubes has an ROCE of 10%. That's a relatively normal return on capital, and it's around the 11% generated by the Metals and Mining industry.

View our latest analysis for Rama Steel Tubes

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'd like to look at how Rama Steel Tubes has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Rama Steel Tubes Tell Us?

When we looked at the ROCE trend at Rama Steel Tubes, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 10% from 25% five years ago. However it looks like Rama Steel Tubes 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.

On a related note, Rama Steel Tubes has decreased its current liabilities to 48% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On Rama Steel Tubes' ROCE

Bringing it all together, while we're somewhat encouraged by Rama Steel Tubes' reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 13% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Rama Steel Tubes (including 2 which are significant) .

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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