Sree Rayalaseema Hi-Strength Hypo (NSE:SRHHYPOLTD) Is Reinvesting At Lower Rates Of Return

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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Sree Rayalaseema Hi-Strength Hypo (NSE:SRHHYPOLTD) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Sree Rayalaseema Hi-Strength Hypo, this is the formula:

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

0.099 = ₹947m ÷ (₹10b - ₹641m) (Based on the trailing twelve months to December 2024).

Thus, Sree Rayalaseema Hi-Strength Hypo has an ROCE of 9.9%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 13%.

See our latest analysis for Sree Rayalaseema Hi-Strength Hypo

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 Sree Rayalaseema Hi-Strength Hypo's past further, check out this free graph covering Sree Rayalaseema Hi-Strength Hypo's past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Sree Rayalaseema Hi-Strength Hypo's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 16%, but since then they've fallen to 9.9%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Sree Rayalaseema Hi-Strength Hypo has decreased its current liabilities to 6.3% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

We're a bit apprehensive about Sree Rayalaseema Hi-Strength Hypo because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these poor fundamentals, the stock has gained a huge 660% over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a final note, we've found 1 warning sign for Sree Rayalaseema Hi-Strength Hypo that we think you should be aware of.

While Sree Rayalaseema Hi-Strength Hypo may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.