Nelco (NSE:NELCO) Might Be Having Difficulty Using Its Capital Effectively

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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So while Nelco (NSE:NELCO) has a high ROCE right now, lets see what we can decipher from how returns are changing.

Return On Capital Employed (ROCE): What Is It?

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)

0.22 = ₹306m ÷ (₹2.9b - ₹1.5b) (Based on the trailing twelve months to December 2022).

So, Nelco has an ROCE of 22%. In absolute terms that's a very respectable return and compared to the Communications industry average of 20% it's pretty much on par.

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. To be more specific, while the ROCE is still high, it's fallen from 38% where it was five years ago. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Nelco has done well to pay down its current liabilities to 52% of total assets. So we could link some of this to the decrease in ROCE. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On Nelco's ROCE

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 long term investors must be optimistic going forward because the stock has returned a huge 214% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you'd like to know about the risks facing Nelco, we've discovered 1 warning sign that you should be aware of.

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.