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

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. So when we looked at Nelco (NSE:NELCO), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

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

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

0.22 = ₹283m ÷ (₹2.6b - ₹1.3b) (Based on the trailing twelve months to June 2022).

Thus, Nelco has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 17% earned by companies in a similar industry.

Check out our latest analysis for Nelco

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

What Does the ROCE Trend For Nelco Tell Us?

In terms of Nelco's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 45%. 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 related note, Nelco has decreased 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. 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. Keep in mind 51% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that Nelco is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 733% 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.

On a separate note, we've found 1 warning sign for Nelco you'll probably want to know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.