Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Speaking of which, we noticed some great changes in Ramkrishna Forgings' (NSE:RKFORGE) returns on capital, so let's have a look.
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 Ramkrishna Forgings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = ₹3.1b ÷ (₹31b - ₹14b) (Based on the trailing twelve months to December 2021).
Thus, Ramkrishna Forgings has an ROCE of 18%. By itself that's a normal return on capital and it's in line with the industry's average returns of 18%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Ramkrishna Forgings' ROCE against it's prior returns. If you'd like to look at how Ramkrishna Forgings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
Investors would be pleased with what's happening at Ramkrishna Forgings. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 18%. Basically the business is earning more per dollar of capital invested and in addition to that, 75% more capital is being employed now too. So we're very much inspired by what we're seeing at Ramkrishna Forgings thanks to its ability to profitably reinvest capital.
On a separate but related note, it's important to know that Ramkrishna Forgings has a current liabilities to total assets ratio of 44%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
To sum it up, Ramkrishna Forgings has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.
If you want to know some of the risks facing Ramkrishna Forgings we've found 2 warning signs (1 is a bit concerning!) that you should be aware of before investing here.
While Ramkrishna Forgings isn't earning the highest return, check out this free list of companies that are 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.