Steel Authority of India (NSE:SAIL) Knows How To Allocate Capital Effectively

What trends should we look for it we want to identify stocks that can 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, the ROCE of Steel Authority of India (NSE:SAIL) looks great, so lets see what the trend can tell us.

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 Steel Authority of India, this is the formula:

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

0.21 = ₹171b ÷ (₹1.2t - ₹393b) (Based on the trailing twelve months to March 2022).

Therefore, Steel Authority of India has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Metals and Mining industry average of 17%.

View our latest analysis for Steel Authority of India

Above you can see how the current ROCE for Steel Authority of India compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Steel Authority of India here for free.

What Does the ROCE Trend For Steel Authority of India Tell Us?

The fact that Steel Authority of India is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 21% on its capital. And unsurprisingly, like most companies trying to break into the black, Steel Authority of India is utilizing 32% more capital than it was five years ago. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

One more thing to note, Steel Authority of India has decreased current liabilities to 33% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

The Bottom Line

In summary, it's great to see that Steel Authority of India has managed to break into profitability and is continuing to reinvest in its business. Since the stock has returned a solid 41% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

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

Steel Authority of 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.

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.