Be Wary Of HFCL (NSE:HFCL) And Its Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating HFCL (NSE:HFCL), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on HFCL is:

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

0.12 = ₹5.3b ÷ (₹65b - ₹22b) (Based on the trailing twelve months to June 2024).

Thus, HFCL has an ROCE of 12%. In absolute terms, that's a pretty standard return but compared to the Telecom industry average it falls behind.

See our latest analysis for HFCL

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 HFCL has performed in the past in other metrics, you can view this free graph of HFCL's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

We weren't thrilled with the trend because HFCL's ROCE has reduced by 59% over the last five years, while the business employed 170% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence HFCL might not have received a full period of earnings contribution from it. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.

On a side note, HFCL has done well to pay down its current liabilities to 34% 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.

The Bottom Line On HFCL's ROCE

Bringing it all together, while we're somewhat encouraged by HFCL's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 694% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

On a final note, we found 2 warning signs for HFCL (1 shouldn't be ignored) you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.