Capital Allocation Trends At Sterlite Technologies (NSE:STLTECH) Aren't Ideal

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Sterlite Technologies (NSE:STLTECH) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

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. To calculate this metric for Sterlite Technologies, this is the formula:

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

0.09 = ₹3.2b ÷ (₹90b - ₹55b) (Based on the trailing twelve months to December 2022).

So, Sterlite Technologies has an ROCE of 9.0%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 20%.

Check out our latest analysis for Sterlite Technologies

In the above chart we have measured Sterlite Technologies' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Sterlite Technologies.

So How Is Sterlite Technologies' ROCE Trending?

In terms of Sterlite Technologies' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 34%, but since then they've fallen to 9.0%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Sterlite Technologies' current liabilities have increased over the last five years to 61% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that Sterlite Technologies is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 52% in the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing: We've identified 3 warning signs with Sterlite Technologies (at least 1 which is a bit unpleasant) , and understanding them would certainly be useful.

While Sterlite Technologies isn't earning the highest return, check out this free list of companies that are 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.