Here's What's Concerning About Innovana Thinklabs' (NSE:INNOVANA) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, while the ROCE is currently high for Innovana Thinklabs (NSE:INNOVANA), we aren't jumping out of our chairs because returns are decreasing.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Innovana Thinklabs:

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

0.26 = ₹221m ÷ (₹1.4b - ₹579m) (Based on the trailing twelve months to September 2021).

Thus, Innovana Thinklabs has an ROCE of 26%. In absolute terms that's a great return and it's even better than the Software industry average of 11%.

Check out our latest analysis for Innovana Thinklabs

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

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Innovana Thinklabs, we didn't gain much confidence. Historically returns on capital were even higher at 42%, but they have dropped over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a separate but related note, it's important to know that Innovana Thinklabs has a current liabilities to total assets ratio of 41%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Innovana Thinklabs' ROCE

To conclude, we've found that Innovana Thinklabs is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 29% over the last three years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

On a final note, we've found 3 warning signs for Innovana Thinklabs that we think you should be aware of.

Innovana Thinklabs 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.

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.

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