Investors Met With Slowing Returns on Capital At Rashtriya Chemicals and Fertilizers (NSE:RCF)

What are the early trends we should look for to identify a stock that could 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So, when we ran our eye over Rashtriya Chemicals and Fertilizers' (NSE:RCF) trend of ROCE, we liked what we saw.

Understanding 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. To calculate this metric for Rashtriya Chemicals and Fertilizers, this is the formula:

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

0.16 = ₹7.8b ÷ (₹98b - ₹48b) (Based on the trailing twelve months to December 2020).

Thus, Rashtriya Chemicals and Fertilizers has an ROCE of 16%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Chemicals industry average of 15%.

View our latest analysis for Rashtriya Chemicals and Fertilizers

Historical performance is a great place to start when researching a stock so above you can see the gauge for Rashtriya Chemicals and Fertilizers' ROCE against it's prior returns. If you're interested in investigating Rashtriya Chemicals and Fertilizers' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

While the current returns on capital are decent, they haven't changed much. The company has employed 41% more capital in the last five years, and the returns on that capital have remained stable at 16%. 16% is a pretty standard return, and it provides some comfort knowing that Rashtriya Chemicals and Fertilizers has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.

Another thing to note, Rashtriya Chemicals and Fertilizers has a high ratio of current liabilities to total assets of 49%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

To sum it up, Rashtriya Chemicals and Fertilizers has simply been reinvesting capital steadily, at those decent rates of return. And the stock has done incredibly well with a 128% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

On a final note, we've found 3 warning signs for Rashtriya Chemicals and Fertilizers that we think you should be aware of.

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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