Sunflag Iron and Steel (NSE:SUNFLAG) May Have Issues Allocating Its Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Although, when we looked at Sunflag Iron and Steel (NSE:SUNFLAG), it didn't seem to tick all of these boxes.

What Is 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. The formula for this calculation on Sunflag Iron and Steel is:

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

0.12 = ₹2.8b ÷ (₹31b - ₹8.8b) (Based on the trailing twelve months to June 2022).

So, Sunflag Iron and Steel has an ROCE of 12%. In absolute terms, that's a pretty standard return but compared to the Metals and Mining industry average it falls behind.

View our latest analysis for Sunflag Iron and Steel

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 Sunflag Iron and Steel's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Sunflag Iron and Steel's ROCE Trending?

When we looked at the ROCE trend at Sunflag Iron and Steel, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Our Take On Sunflag Iron and Steel's ROCE

While returns have fallen for Sunflag Iron and Steel in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 66% to shareholders over the last five years. 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.

On a final note, we've found 2 warning signs for Sunflag Iron and Steel that we think you should be aware of.

While Sunflag Iron and Steel 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.