Here's What's Concerning About Tata Steel's (NSE:TATASTEEL) Returns On Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. In light of that, from a first glance at Tata Steel (NSE:TATASTEEL), we've spotted some signs that it could be struggling, so let's investigate.

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 Tata Steel is:

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

0.055 = ₹94b ÷ (₹2.7t - ₹1.0t) (Based on the trailing twelve months to September 2023).

Therefore, Tata Steel has an ROCE of 5.5%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 14%.

Check out our latest analysis for Tata Steel

In the above chart we have measured Tata Steel's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Tata Steel here for free.

So How Is Tata Steel's ROCE Trending?

In terms of Tata Steel's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 13%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Tata Steel becoming one if things continue as they have.

The Bottom Line

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Since the stock has skyrocketed 235% 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.

If you'd like to know more about Tata Steel, we've spotted 2 warning signs, and 1 of them doesn't sit too well with us.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.