Nelco (NSE:NELCO) Is Reinvesting At Lower Rates Of Return

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Looking at Nelco (NSE:NELCO), it does have a high ROCE right now, but lets see how returns are trending.

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. To calculate this metric for Nelco, this is the formula:

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

0.24 = ₹307m ÷ (₹2.6b - ₹1.3b) (Based on the trailing twelve months to March 2022).

Thus, Nelco has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Communications industry average of 16%.

See our latest analysis for Nelco

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Nelco's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Nelco Tell Us?

When we looked at the ROCE trend at Nelco, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 44%. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Nelco has done well to pay down its current liabilities to 51% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 51% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line

While returns have fallen for Nelco in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has done incredibly well with a 694% return over the last five 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.

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

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.