Sirca Paints India (NSE:SIRCA) Could Be Struggling To Allocate Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, while the ROCE is currently high for Sirca Paints India (NSE:SIRCA), we aren't jumping out of our chairs because returns are decreasing.

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. The formula for this calculation on Sirca Paints India is:

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

0.25 = ₹529m ÷ (₹2.5b - ₹424m) (Based on the trailing twelve months to September 2021).

Thus, Sirca Paints India has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Retail Distributors industry average of 3.8%.

View our latest analysis for Sirca Paints India

In the above chart we have measured Sirca Paints India'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 Sirca Paints India here for free.

The Trend Of ROCE

When we looked at the ROCE trend at Sirca Paints India, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 53%. 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.

On a related note, Sirca Paints India has decreased its current liabilities to 17% 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.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that Sirca Paints India is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 259% return over the last three years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

Sirca Paints India does have some risks though, and we've spotted 1 warning sign for Sirca Paints India that you might be interested in.

Sirca Paints India is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.