Tata Consultancy Services (NSE:TCS) Is Very Good At Capital Allocation

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. With that in mind, the ROCE of Tata Consultancy Services (NSE:TCS) looks great, so lets see what the trend can tell us.

Understanding 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 Consultancy Services is:

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

0.45 = ₹524b ÷ (₹1.6t - ₹425b) (Based on the trailing twelve months to December 2022).

Thus, Tata Consultancy Services has an ROCE of 45%. In absolute terms that's a great return and it's even better than the IT industry average of 12%.

See our latest analysis for Tata Consultancy Services

In the above chart we have measured Tata Consultancy Services' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

The trends we've noticed at Tata Consultancy Services are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 45%. Basically the business is earning more per dollar of capital invested and in addition to that, 41% more capital is being employed now too. So we're very much inspired by what we're seeing at Tata Consultancy Services thanks to its ability to profitably reinvest capital.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 27% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line On Tata Consultancy Services' ROCE

In summary, it's great to see that Tata Consultancy Services can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And a remarkable 151% total return over the last five years tells us that investors are expecting more good things to come in the future. Therefore, we think it would be worth your time to check if these trends are going to continue.

Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation that compares the share price and estimated value.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.