When researching a stock for investment, what can tell us that the company is in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. So after we looked into India Power (NSE:DPSCLTD), the trends above didn't look too great.
What is Return On Capital Employed (ROCE)?
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 India Power:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.02 = ₹407m ÷ (₹25b - ₹5.0b) (Based on the trailing twelve months to September 2020).
So, India Power has an ROCE of 2.0%. In absolute terms, that's a low return and it also under-performs the Electric Utilities industry average of 7.3%.
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 want to delve into the historical earnings, revenue and cash flow of India Power, check out these free graphs here.
So How Is India Power's ROCE Trending?
The trend of returns that India Power is generating are raising some concerns. To be more specific, today's ROCE was 2.6% five years ago but has since fallen to 2.0%. What's equally concerning is that the amount of capital deployed in the business has shrunk by 25% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
To see India Power reducing the capital employed in the business in tandem with diminishing returns, is concerning. In spite of that, the stock has delivered a 38% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
One final note, you should learn about the 3 warning signs we've spotted with India Power (including 1 which can't be ignored) .
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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