RHI Magnesita India's (NSE:RHIM) Returns On Capital Not Reflecting Well On The Business

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. 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)?

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 RHI Magnesita India is:

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

0.26 = ₹2.4b ÷ (₹16b - ₹6.5b) (Based on the trailing twelve months to September 2021).

Thus, RHI Magnesita India has an ROCE of 26%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.

See our latest analysis for RHI Magnesita India

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 RHI Magnesita India has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of RHI Magnesita India's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 39%. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 41%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 26%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that RHI Magnesita India is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 217% to shareholders in the last five years. 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.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for RHI Magnesita India (of which 1 is a bit concerning!) that you should know about.

RHI Magnesita India is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.