Capital Allocation Trends At Rossari Biotech (NSE:ROSSARI) Aren't Ideal

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Rossari Biotech (NSE:ROSSARI) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Rossari Biotech, this is the formula:

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

0.13 = ₹1.2b ÷ (₹13b - ₹3.6b) (Based on the trailing twelve months to September 2021).

So, Rossari Biotech has an ROCE of 13%. In isolation, that's a pretty standard return but against the Chemicals industry average of 17%, it's not as good.

See our latest analysis for Rossari Biotech

In the above chart we have measured Rossari Biotech's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Rossari Biotech.

What Does the ROCE Trend For Rossari Biotech Tell Us?

The trend of ROCE doesn't look fantastic because it's fallen from 36% four years ago, while the business's capital employed increased by 1,060%. Usually this isn't ideal, but given Rossari Biotech conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Rossari Biotech's earnings and if they change as a result from the capital raise.

On a related note, Rossari Biotech has decreased its current liabilities to 28% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

While returns have fallen for Rossari Biotech in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 73% over the last year, it would appear that investors are upbeat about the future. 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.

One final note, you should learn about the 2 warning signs we've spotted with Rossari Biotech (including 1 which makes us a bit uncomfortable) .

While Rossari Biotech isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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.

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