The Trends At Sunflag Iron and Steel (NSE:SUNFLAG) That You Should Know About

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. In light of that, when we looked at Sunflag Iron and Steel (NSE:SUNFLAG) and its ROCE trend, we weren't exactly thrilled.

What is 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. Analysts use this formula to calculate it for Sunflag Iron and Steel:

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

0.06 = ₹1.1b ÷ (₹24b - ₹5.4b) (Based on the trailing twelve months to September 2020).

Therefore, Sunflag Iron and Steel has an ROCE of 6.0%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 9.4%.

View our latest analysis for Sunflag Iron and Steel

Historical performance is a great place to start when researching a stock so above you can see the gauge for Sunflag Iron and Steel's ROCE against it's prior returns. If you'd like to look at how Sunflag Iron and Steel has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Sunflag Iron and Steel, we didn't gain much confidence. Around five years ago the returns on capital were 17%, but since then they've fallen to 6.0%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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, Sunflag Iron and Steel has decreased its current liabilities to 23% of total assets. That could partly explain why the ROCE has dropped. 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.

What We Can Learn From Sunflag Iron and Steel's ROCE

In summary, we're somewhat concerned by Sunflag Iron and Steel's diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 161% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Sunflag Iron and Steel does have some risks though, and we've spotted 1 warning sign for Sunflag Iron and Steel that you might be interested in.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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