Sree Rayalaseema Hi-Strength Hypo's (NSE:SRHHYPOLTD) Returns On Capital Not Reflecting Well On The Business

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after briefly looking over the numbers, we don't think Sree Rayalaseema Hi-Strength Hypo (NSE:SRHHYPOLTD) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.11 = ₹914m ÷ (₹9.1b - ₹543m) (Based on the trailing twelve months to June 2024).

Thus, Sree Rayalaseema Hi-Strength Hypo has an ROCE of 11%. In absolute terms, that's a pretty standard return but compared to the Chemicals industry average it falls behind.

Check out our latest analysis for Sree Rayalaseema Hi-Strength Hypo

Historical performance is a great place to start when researching a stock so above you can see the gauge for Sree Rayalaseema Hi-Strength Hypo's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Sree Rayalaseema Hi-Strength Hypo.

What Does the ROCE Trend For Sree Rayalaseema Hi-Strength Hypo Tell Us?

On the surface, the trend of ROCE at Sree Rayalaseema Hi-Strength Hypo doesn't inspire confidence. To be more specific, ROCE has fallen from 14% over the last five years. 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 side note, Sree Rayalaseema Hi-Strength Hypo has done well to pay down its current liabilities to 5.9% 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

From the above analysis, we find it rather worrisome that returns on capital and sales for Sree Rayalaseema Hi-Strength Hypo have fallen, meanwhile the business is employing more capital than it was five years ago. Since the stock has skyrocketed 563% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing to note, we've identified 2 warning signs with Sree Rayalaseema Hi-Strength Hypo and understanding these should be part of your investment process.

While Sree Rayalaseema Hi-Strength Hypo 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.