Nelco (NSE:NELCO) May Have Issues Allocating Its Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So while Nelco (NSE:NELCO) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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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 Nelco:

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

0.20 = ₹295m ÷ (₹2.8b - ₹1.4b) (Based on the trailing twelve months to December 2024).

Thus, Nelco has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Communications industry average of 7.3%.

View 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'd like to look at how Nelco has performed in the past in other metrics, you can view this free graph of Nelco's past earnings, revenue and cash flow.

The Trend Of ROCE

On the surface, the trend of ROCE at Nelco doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 26% where it was five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a separate but related note, it's important to know that Nelco has a current liabilities to total assets ratio of 49%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Nelco's ROCE

To conclude, we've found that Nelco is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 410% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you're still interested in Nelco it's worth checking out our FREE intrinsic value approximation for NELCO to see if it's trading at an attractive price in other respects.

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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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.