RHI Magnesita India (NSE:RHIM) Might Be Having Difficulty Using Its Capital Effectively

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. So while RHI Magnesita India (NSE:RHIM) has a high ROCE right now, lets see what we can decipher from how returns are changing.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for RHI Magnesita India, this is the formula:

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

0.31 = ₹2.8b ÷ (₹16b - ₹6.5b) (Based on the trailing twelve months to December 2021).

Thus, RHI Magnesita India has an ROCE of 31%. In absolute terms that's a great return and it's even better than the Basic Materials industry average of 12%.

See our latest analysis for RHI Magnesita India

Historical performance is a great place to start when researching a stock so above you can see the gauge for RHI Magnesita India's ROCE against it's prior returns. If you'd like to look at how RHI Magnesita India has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From RHI Magnesita India's ROCE Trend?

In terms of RHI Magnesita India's historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 40%, but they have dropped over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, RHI Magnesita India's current liabilities have increased over the last five years to 41% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 31%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for RHI Magnesita India. And the stock has done incredibly well with a 380% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

If you want to continue researching RHI Magnesita India, you might be interested to know about the 3 warning signs that our analysis has discovered.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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

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.