If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we’ll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company’s amount of capital employed. If you see this, it typically means it’s a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating UPL (NSE:UPL), we don’t think it’s current trends fit the mold of a multi-bagger.
Understanding Return On Capital Employed (ROCE)
For those who don’t know, ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for UPL, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.10 = ₹54b ÷ (₹701b – ₹167b) (Based on the trailing twelve months to June 2020).
Thus, UPL has an ROCE of 10%. In isolation, that’s a pretty standard return but against the Chemicals industry average of 14%, it’s not as good.
In the above chart we have measured UPL’s prior ROCE against its prior performance, but the future is arguably more important. If you’d like to see what analysts are forecasting going forward, you should check out our free report for UPL.
How Are Returns Trending?
On the surface, the trend of ROCE at UPL doesn’t inspire confidence. Over the last five years, returns on capital have decreased to 10% from 24% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.On a related note, UPL has decreased its current liabilities to 24% of total assets. That could partly explain why the ROCE has dropped. What’s more, this can reduce some aspects of risk to the business because now the company’s suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business’ efficiency at generating ROCE since it is now funding more of the operations with its own money.
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for UPL. And the stock has followed suit returning a meaningful 80% to shareholders over the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
One more thing to note, we’ve identified 1 warning sign with UPL and understanding this should be part of your investment process.
While UPL 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. 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.
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