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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Having said that, from a first glance at Seshasayee Paper and Boards (NSE:SESHAPAPER) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper 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. Analysts use this formula to calculate it for Seshasayee Paper and Boards:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.06 = ₹823m ÷ (₹16b - ₹2.1b) (Based on the trailing twelve months to December 2021).
So, Seshasayee Paper and Boards has an ROCE of 6.0%. Ultimately, that's a low return and it under-performs the Forestry industry average of 12%.
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're interested in investigating Seshasayee Paper and Boards' past further, check out this free graph of past earnings, revenue and cash flow.
What Can We Tell From Seshasayee Paper and Boards' ROCE Trend?
When we looked at the ROCE trend at Seshasayee Paper and Boards, we didn't gain much confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 6.0%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, Seshasayee Paper and Boards has done well to pay down its current liabilities to 13% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 On Seshasayee Paper and Boards' ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Seshasayee Paper and Boards. Furthermore the stock has climbed 49% over the last five years, 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.
Seshasayee Paper and Boards does have some risks, we noticed 3 warning signs (and 1 which is concerning) we think you should know about.
While Seshasayee Paper and Boards 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.