Investors Could Be Concerned With Tata Elxsi's (NSE:TATAELXSI) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. So while Tata Elxsi (NSE:TATAELXSI) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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. Analysts use this formula to calculate it for Tata Elxsi:

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

0.33 = ₹4.8b ÷ (₹17b - ₹2.6b) (Based on the trailing twelve months to March 2021).

Therefore, Tata Elxsi has an ROCE of 33%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.

View our latest analysis for Tata Elxsi

Historical performance is a great place to start when researching a stock so above you can see the gauge for Tata Elxsi's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Tata Elxsi, check out these free graphs here.

The Trend Of ROCE

In terms of Tata Elxsi's historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 56%, but they have dropped over the last five years. 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 side note, Tata Elxsi has done well to pay down its current liabilities to 15% of total assets. So we could link some of this to the decrease in ROCE. 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.

What We Can Learn From Tata Elxsi's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Tata Elxsi is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 298% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One more thing, we've spotted 2 warning signs facing Tata Elxsi that you might find interesting.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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