Tata Communications (NSE:TATACOMM) Shareholders Will Want The ROCE Trajectory To Continue

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So on that note, Tata Communications (NSE:TATACOMM) looks quite promising in regards to its trends of return on capital.

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

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. Analysts use this formula to calculate it for Tata Communications:

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

0.18 = ₹21b ÷ (₹201b - ₹83b) (Based on the trailing twelve months to September 2022).

Therefore, Tata Communications has an ROCE of 18%. By itself that's a normal return on capital and it's in line with the industry's average returns of 18%.

Our analysis indicates that TATACOMM is potentially undervalued!

Above you can see how the current ROCE for Tata Communications compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Tata Communications here for free.

The Trend Of ROCE

Tata Communications has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 293% over the last five years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

On a side note, Tata Communications' current liabilities are still rather high at 41% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

To bring it all together, Tata Communications has done well to increase the returns it's generating from its capital employed. Since the stock has returned a solid 95% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

One more thing to note, we've identified 2 warning signs with Tata Communications and understanding them should be part of your investment process.

While Tata Communications 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.